ACG 3141 CH 12

Intangibles have either a limited useful life or an indefinite useful life. How should these two different types of intangibles be amortized?

Limited-life intangibles should be amortized by systematic charges to expense over their useful life. An intangible asset with an indefinite life is not amortized.

Why does the accounting profession make a distinction between internally created intangibles and purchased intangibles?

When intangibles are created internally, it is often difficult to determine the validity of any future service potential. To permit deferral of these types of costs would lead to a great deal of subject-tivity because management could argue that almost any expense could be capitalized on the basis that it will increase future benefits. The cost of purchased intangibles, however, is capitalized because its cost can be objectively verified and reflects its fair value at the date of acquisition.

Indicate the proper accounting for the following items. a. Organization costs. c. Operating losses. b. Advertising costs.

Each of these items should be charged to current operations. Advertising costs have some minor exceptions to this general rule. However, the specific accounting is beyond the scope of this textbook.

What are factors to be considered in estimating the useful life of an intangible asset?

Factors to be considered in determining useful life are: (a) The expected use of the asset by the entity. (b) The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate. (c) Any legal, regulatory, or contractual provisions that may limit useful life. (d) Any legal, regulatory or contractual provisions that enable renewal or extension of the asset's legal or contractual life without substantial cost. (e) The effects of obsolescence, demand, competition, and other economic factors. (f) The level of maintenance expenditure required to obtain the expected future cash flows from the asset.

In 2019, Austin Powers Corporation developed a new product that will be marketed in 2020. In connection with the development of this product, the following costs were incurred in 2019: research and development costs $400,000, materials and supplies consumed $60,000, and compensation paid to research consultants $125,000. It is anticipated that these costs will be recovered in 2022. What is the amount of research and development costs that Austin Powers should record in 2019 as a charge to expense?

$585,000 ($400,000 + $60,000 + $125,000).

In examining financial statements, financial analysts often write off goodwill immediately. Comment on this procedure.

Many analysts believe that the value of goodwill is so subjective that it should not be given the same status as other types of assets such as cash, receivables, inventory, etc. The analysts are simply stating that they believe that presentation of goodwill on the balance sheet does not provide any useful information to the users of financial statements. Whether this is true or not is a difficult point to prove, but it should be noted that it appears contradictory to pay for the goodwill and then immediately write it off, denying that it has any value.

What is the nature of research and development costs?

Research and development costs are incurred to develop new products or processes, to improve present products, or to discover new knowledge. R&D expenditures present problems of (1) identifying the costs associated with particular activities, projects, or achievements, and (2) determining the magnitude of the future benefits and the length of time over which such benefits may be realized. R&D activities may incur costs classified as follows: (a) materials, equipment, and facilities, (b) personnel, (c) purchased intangibles, (d) contract services, and (e) indirect costs.

Romo Company spent $190,000 developing a new process, $45,000 in legal fees to obtain a patent, and $91,000 to market the process that was patented, all in the year 2020. How should these costs be accounted for in 2020?

The $190,000 should be expensed as research and development expense in 2017. The $91,000 is expensed as selling and promotion expense in 2017. The $45,000 of costs to legally obtain the patent should be capitalized and amortized over the useful or legal life of the patent, whichever is shorter.

What should be the pattern of amortization for a limited-life intangible?

The amount of amortization expensed for a limited-life intangible asset should reflect the pattern in which the asset is consumed or used up, if that pattern can be reliably determined. If the pattern of production or consumption cannot be determined, the straight-line method of amortization should be used.

Simon Company determines that its goodwill is impaired. It finds that the book value of its reporting unit is $1,490,000, including re- corded goodwill of $400,000. The fair value of the identifiable assets of the reporting unit is $1,450,000. What is the amount of goodwill impaired?

The amount of goodwill impaired is $40,000, computed as follows: Recorded goodwill.................................................. $400,000 Implied goodwill...................................................... (360,000) Impaired goodwill................................................... $ 40,000

Columbia Sportswear Company acquired a trademark that is helpful in distinguishing one of its new products. The trade- mark is renewable every 10 years at minimal cost. All evidence indicates that this trademarked product will generate cash flows for an indefinite period of time. How should this trademark be amortized?

This trademark is an indefinite life intangible and, therefore, should not be amortized.

Last year, Zeno Company recorded an impairment on an intan- gible asset held for use. Recent appraisals indicate that the asset has increased in value. Should Zeno record this recovery in value?

Under U.S. GAAP, impairment losses on assets held for use may not be restored.

Which of the following activities should be expensed currently as R&D costs? a. Testing in search for or evaluation of product or process alternatives. b. Engineering follow-through in an early phase of commercial production. c. Legal work in connection with patent applications or litiga- tion, and the sale or licensing of patents.

a) Expense as R&D. (b) Expense as R&D. (c) Capitalize as patent and/or license and amortize. Also, see Illustration 12-15 (page 22).

Research and development activities may include (a) personnel costs, (b) materials and equipment costs, and (c) indirect costs. What is the recommended accounting treatment for these three types of R&D costs?

a) Personnel (labor) type costs incurred in R&D activities should be expensed as incurred. (b) Materials and equipment costs should be expensed immediately unless the items have alternative future uses. If the items have alternative future uses, the materials should be recorded as inventories and allocated as consumed and the equipment should be capitalized and depreciated as used. (c) Indirect costs of R&D activities should be reasonably allocated to R&D (except for general and administrative costs, which must be clearly related to be included) and expensed.

Explain the difference between artistic-related intangible assets and contract-related intangible assets.

Artistic-related intangible assets involve ownership rights to plays, pictures, photographs, and video and audiovisual material. These ownership rights are protected by copyrights. Contract-related intangible assets represent the value of rights that arise from contractual arrangements. Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts.

Braxton Inc. is considering the write-off of a limited-life intangi- ble because of its lack of profitability. Explain to the management of Braxton how to determine whether a write-off is permitted.

Accounting standards require that if events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, then the carrying amount of the asset should be assessed. The assessment or review takes the form of a recoverability test that compares the sum of the expected future cash flows from the asset (undiscounted) to the carrying amount. If the cash flows are less than the carrying amount, the asset has been impaired. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset. The fair value of assets is measured by their fair value if an active market for them exists. If no market price is available, the present value of the expected future net cash flows from the asset may be used.

Izzy Inc. purchased a patent for $350,000 which has an estimated useful life of 10 years. Its pattern of use or consumption cannot be reliably determined. Prepare the entry to record the amortization of the patent in its first year of use.

Amortization Expense............................................................................................ 35,000 Patents (or Accumulated Patent Amortization)................................................... 35,000 Straight-line amortization is used because the pattern of use cannot be reliably determined.

In 2020, Ghostbusters Corp. spent $420,000 for "goodwill" visits by sales personnel to key customers. The purpose of these visits was to build a solid, friendly relationship for the future and to gain insight into the problems and needs of the companies served. How should this expenditure be reported?

Companies cannot capitalize self-developed, self-maintained, or self-created goodwill. These expenditures would most likely be reported as selling expenses.

Under what circumstances is it appropriate to record goodwill in the accounts? How should goodwill, properly recorded on the books, be written off in order to conform with generally accepted accounting principles?

Goodwill is recorded only when it is acquired by purchase. Goodwill acquired in a business combination is considered to have an indefinite life and therefore should not be amortized, but should be tested for impairment on at least an annual basis.

If intangibles are acquired for stock, how is the cost of the intan- gible determined?

If intangibles are acquired for stock, the cost of the intangible is the fair value of the consideration given or the fair value of the consideration received, whichever is more clearly evident.

Explain how losses on impaired intangible assets should be re- ported in income.

Impairment losses are reported as part of income from continuing operations, generally in the "Other expenses and losses" section. Impairment losses (and recovery of losses for assets to be disposed of) are similar to other costs that would flow through operations. Thus, gains (recoveries of losses) on assets to be disposed of should be reported as part of income from continuing operations.

An intangible asset with an estimated useful life of 30 years was acquired on January 1, 2010, for $540,000. On January 1, 2020, a re- view was made of intangible assets and their expected service lives, and it was determined that this asset had an estimated useful life of 30 more years from the date of the review. What is the amount of amortization for this intangible in 2020?

The total life, per revised facts, is 40 years (10 + 30). There are 30 (40 - 10) remaining years for amortization purposes. Original amortization: = $18,000 per year; $18,000 X 10 years expired = $180,000 accumulated amortization. $540,000 original cost -180,000 accumulated amortization $360,000 remaining cost to amortize $360,000 ÷ 30 years = $12,000 amortization for 2017 and years thereafter.

What are the two main characteristics of intangible assets?

The two main characteristics of intangible assets are: (a) they lack physical substance. (b) they are not a financial instrument.

Recently, a group of university students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct?

These costs are referred to as start-up costs, or more specifically organizational costs in this case. The accounting for start-up costs is straightforward—expense these costs as incurred. The profession recognizes that these costs are incurred with the expectation that future revenues will occur or increased efficiencies will result. However, to determine the amount and timing of future benefits is so difficult that a conservative approach—expensing these costs as incurred—is required.

What is goodwill? What is a bargain purchase?

Varying approaches are used to define goodwill. They are (a) Goodwill should be measured initially as the excess of the fair value of the acquisition cost over the fair value of the net assets acquired. This definition is a measurement definition but does not conceptually define goodwill. (b) Goodwill is sometimes defined as one or more unidentified intangible assets and identifiable intangible assets that are not reliably measurable. Examples of elements of goodwill include new channels of distribution, synergies of combining sales forces, and a superior management team. (c) Goodwill may also be defined as the intrinsic value that a business has acquired beyond the mere value of its net assets whether due to the personality of those conducting it, the nature of its location, its reputation, or any other circumstance incidental to the business and tending to make it permanent. Another definition is the capitalized value of the excess of estimated future profits of a business over the rate of return on capital considered normal in the industry. A bargain purchase (or negative goodwill) occurs when the fair value of the assets purchased is higher than the cost. This situation may develop from a market imperfection. In this case, the seller would have been better off to sell the assets individually than in total. However, situations do occur (e.g., a forced liquidation or distressed sale due to the death of the company founder), in which the purchase price is less than the value of the identifiable net assets.