Chapter 12: Intangible Assets

Purchased intangibles are recorded at...

Cost. Includes purchase price, legal fees, and other incidental expenses. If acquired by exchanging stock or other assets, the cost is fair value of consideration given or intangible asset received, whichever is more clearly evident.

Patents

Exclusive right to use, manufacture, and sell a product or service for 20 years.

Advertising costs

Expensed as incurred, or when advertising first takes place.

Contract service costs

Expensed as incurred.

Personnel costs

Expensed as incurred.

Start-up costs

Expensed as incurred.

Implied fair value of goodwill

Fair value of reporting unit - fair value of identifiable net assets. If the implied fair value of goodwill is less than its carrying amount, an impairment loss equal to the difference is recognized.

Accounting for research and development costs

Generally expensed as incurred, unless they have alternative future uses. If alternative future uses exist, carry costs as inventory and allocate as consumed, or capitalize and depreciate as used. During the period the asset is used for research and development, depreciation is included in research and development expense. Materials, equipment, and facilities. All research and development costs incurred internally should be expensed. ASC 730-10-25-2 does not cover research performed under contract by the reporting company for others. Thus, if firm A does research under contract for firm B, the former may capitalize those costs (as a receivable) while the latter expenses them.

Goodwill write-off

Goodwill considered to have an indefinite-life intangible, therefore is not subject to amortization. Goodwill is tested annually for impairment and is only charged if it has been impaired. Negative goodwill. FASB requires that the excess be recognized as a gain. The company is required to disclose the nature of the gain.

Goodwill is referred to as a...

"Master valuation" account because it is the residual amount left after subtracting the fair value of identifiable net assets acquired from the purchase price paid for the acquired business.

Journal entry to record impairment

Impairment loss XX - Intangible asse XX

Research and development costs

Include expenditures to discover new knowledge, products, processes, and techniques. Include construction of pilot plants and prototypes. Do not include legal work, routine improvements, or periodic retooling. Exclude research related to selling and administrative activities.

Indefinite-life intangibles

Not amortized. They are tested for impairment at least annually.

Customer-related intangible assets

Occur as a result of interactions with outside parties. Customer lists, order or production backlogs, and contractual or non-contractual customer relationships. Amortized over the asset's useful life. Residual value is zero, unless reliable evidence exists about the residual value.

Negative goodwill (bargain purchase)

Occurs when fair value of net assets acquired is greater than the purchase price.

Internally-created intangible

Only direct cost incurred in obtaining the intangible (e.g., legal cost) are capitalized, all other costs (e.g., research and development costs) are expensed. In general, cost of internally created intangibles are recognized as expenses when incurred.

Examples of intangible assets

Patents Copyrights Franchises or licenses Trademarks or trade names Goodwill

Marketing-related intangible assets

Primarily used in the marketing or promotion of products or services. Trademarks and trade names. Company names

Purchased intangibles

Recognize and measure at fair value. After initial recognition, account for in accordance with their nature.

Intangibles other than goodwill

Recoverability test is not used. A one-step test (fair value test). If the fair value of an intangible is less than its carrying amount, an impairment loss is recognized for the difference. Restoration of impairment loss is not permited

Technology-related intangible assets

Relate to innovations or technological advances. Patents. Amortized over the useful life or legal life, whichever is shorter. Legal fees and other costs incurred in successfully defending a patent suit should be capitalized. The cost of unsuccessfully defending a patent should be expensed. The purchase price of a competing patent should be added to the cost of the original patent.

Goodwill

Represents the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized. It is only recorded when an entire business is purchased because goodwill is a "going concern" valuation and cannot be separated from the business as a whole. Internally generated goodwill is not capitalized. Purchased goodwill is recorded as the excess of the fair value of the consideration transferred over the fair value of the identifiable net assets acquired. Assets acquired and liabilities assumed are recorded at fair value.

Contract-related intangible assets

Rights that arise from contractual arrangements Franchise Corporate Governmental (licenses or permits) Limited-life franchises should be amortized over their useful lives. Indefinite-life franchises should not be amortized. They should be tested annually for impairment. Annual payments based on revenues or serves under a franchise agreement should be expensed.

Impairment of limited-life intangibles

Same as impairment for long-lived assets. Review events for possible impairment. Apply recoverability test to determine if impairment has occurred. Impairment occurs when the sum of the expected future net cash flows (undiscounted) of an asset is less than the asset's carrying value. If impairment has occurred, recognize impairment loss for the amount by which the carrying value of the asset exceeds the fair value of the asset. If no active market exists, use the present value of expected future net cash flows. The loss is reported as part of income from continuing operations, "other expenses and losses" section. The new cost basis of the asset is the reduced carrying amount. The cost basis is not written up, even if the fair value of the asset increases in future years. Amortization is taken on the new cost basis over the asset's remaining useful life, or legal life, whichever is shorter.

Other costs similar to research and development costs

Start-up costs Initial operating losses Advertising costs

Research

The planned search or critical investigation aimed at discovery of new knowledge.

Development

The translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use.

Intangible asset characteristics

They lack physical substance. They are not financial instruments.

Indirect costs

A reasonable allocation is included in research and development and expensed as incurred.

The notes to the financial statements should include

Aggregate estimated amortization expense for each of next 5 years. Changes in the carrying amount of goodwill during the period. The total research and development costs charged to expense in each period for which an income statement is presented.

Journal entry for amortization

Amortization expense XX -Intangible asset XX

The income statement should reflect

Amortization expense and impairment losses for all intangibles other than goodwill. Goodwill impairment losses should be shown as separate item in continuing operations.

Limited-life intangibles

Amortized over their useful lives.

Trademarks and trade names

Considered to be indefinite-life intangibles since they may be renewed for an indefinite number of 10 year periods. They are not amortized. They are tested annually for impairment. If insignificant cost, it is usually expensed.

Franchise

Contractual arrangement under which the franchiser grants the franchisee certain rights.

Amortizable base is equal to...

Cost less residual value.

Initial operating losses

Do not capitalize.

Factors affecting useful life

Expected use of the asset. Expected useful life of a related asset. Any legal, regulatory, or contractual provisions that may limit the useful life. Provisions that enable renewal of extension of the asset's legal or contractual life without substantial cost. The effects of obsolescence, demand, competition, and other economic factors. The level of maintenance expenditure required to obtain the expected future cash flows from the asset.

Impairment of indefinite-life intangibles

An intangible asset that is not subject to amortization shall be tested for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. A company has the option to first assess qualitative factors to determine if it is more likely than not (that is, a likelihood of more than 50 percent) that an indefinite-lived intangible asset is impaired. If after assessing the totality of events and circumstances, the company determines that it is more likely than not that the asset is not impaired, then the company is not required to take further action. If, however, the company concludes otherwise, it is required to perform a quantitative impairment test (fair value test). The company has an unconditional option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. The company may resume performing the qualitative assessment in any subsequent period. In assessing whether it is more likely than not that an indefinite-lived intangible asset is impaired, the company must assess all relevant events and circumstances that could affect the significant inputs used to determine the fair value of the indefinite-lived intangible asset.

Presentation of intangibles

Intangibles are usually reported at their unamortized cost. All intangibles other than goodwill should be combined together and reported as a separate line item. If goodwill is present, it should be reported as a separate line item.

Impairment of goodwill

Involves a two-step process. If the fair value of the reporting unit level is less than its carrying amount including goodwill then the second step is performed; otherwise, the unit is not impaired, goodwill is not impaired and the second step is not performed. In the second step, the implied fair value of goodwill must be determined and compared to its carrying amount.

Types of intangible assets

Marketing-related intangible assets. Customer-related intangible assets. Artistic-related intangible assets. Contract-related intangible assets. Technology-related intangible assets. Goodwill.

Residual value is assumed to be...

Zero, unless the intangible has value to another entity at the end of its useful life.

Companies should evaluate the limited-life intangible for...

impairment if conditions indicate they may be impaired.

Artistic-related intangible assets

ownership rights to plays, literary works, musical works, pictures, photographs, and video and audiovisual material. Copyrights are granted for the life of the creator plus 70 years. Useful life is usually less than legal life. Amortized over useful life. Costs of defending a copyright are capitalized.