chapter 12

START-UP COSTS are incurred for one-time activities to start a new operation. Examples include opening a new plant, introducing a new product or service, or conducting business in a new territory.

Start-up costs include ORGANIZATIONAL COSTS, such as legal and state fees incurred a new business entity.

DESCRIBE THE CHARACTERISTICS OF INTANGIBLE ASSETS. intangible assets have two main characteristics:

(1) they lack physical existence, and (2) they are not financial instruments. In most cases, intangible assets provide services over a period of years and so are normally classified as long-term assets.

Research and development (R&D) costs are not in themselves intangible assets. However, we present the accounting for R&D costs here because R&D activities frequently result in the development of patents or copyrights

(such as a new product, process, idea, formula, composition, or literary work) that may provide future value.

amortization expense should reflect the pattern, if reliably determined, in which a company sues up the patent. a company may credit amortization of patents directly to the Patents account or to an Accumulated Patent Amortization account.

**************January 1, 2014 Patent 180,000 ****Cash 180,000 (To record legal fees related to patent) ************** December 31,2014 Amortization Expense 15,000 ****Patents (or Accumulated Patent Amortization) 15,000 (To record amortization of patent)

sometimes companies acquire intangibles in exchange for stock or other assets. in such cases

, THE COST OF THE INTANGIBLE IS THE FAIR VALUE OF THE CONSIDERATION GIVEN OR THE FAIR VALUE OF THE INTANGIBLE RECEIVED, WHICHEVER IS MORE CLEARLY EVIDENT.

many costs have characteristics similar to research and development costs. Examples are:

1. start-up costs for a new operation. 2. initial operating losses. 3. advertising costs. 4. computer software costs.

There are many different types of intangibles, often classified into the following six major categories. 1. marketing-related intangible assets. 2. customer-related intangible assets. 3. Artistic-related intangible assets

4. contract-related intangible assets. 5. technology-related intangible assets. 6. goodwill.

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.

A FRANCHISE is a contractual arrangement under which the franchiser grants the franchisee the right to sell certain products or services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area.

companies should amortize the cost of a patent over its legal life or its useful life (the period in which benefits are received), WHICHEVER IS SHORTER. As mentioned earlier. companies capitalize the costs of defending copyrights.the accounting treatment for a patent defense is similar.

A company charges all unrecovered legal fees and other costs incurred in successfully defending a patent suit to Patents, an asset account. Such costs should be amortized along with acquisition cost over the remaining useful life of the patent.

companies primarily use marketing-related intangible assets in the marketing or promotion of products or services. Examples are trademarks or trade names, newspaper mastheads, Internet domain names, and noncompetition agreements.

A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular company or product.

in some cases, the carrying amount of along-lived asset - property, plant, and equipment, or intangible assets) is not recoverable. Therefore, a company needs to record a write-off. This is write-off is referred to as IMPAIRMENT. The rules that apply to IMPAIRMENTS OF PROPERTY, PLANT, AND EQUIPMENT

ALSO APPLY TO LIMITED-LIFE INTANGIBLES. A company should review property, plant, and equipment for impairment at certain points-whenever events or changes in circumstances indicate that the carrying amount of asset may not be recoverable.

if no factors (legal, regulatory, contractual, competitive, or other) limit the useful life of an intangible asset, a company considers its useful life indefinite.

An indefinite life means that there is no foreseeable limit on the period of time over which the intangible asset is expected to provide cash flows.

The company then uses the FAIR VALUE TEST. this test measures the impairment loss by comparing the asset's fair value with its carrying amount. The impairment loss is carrying amount of the asset less the fair value of the impaired asset.

As with other impairments, the loss on the limited-life intangible is reported as part of income from continuing operations. The entry generally appears in the "OTHER EXPENSES AND LOSSES" section.

PURCHASED INTANGIBLES. recognize and measure at fair value. After initial recognition, account for in accordance with their nature (as either limited-life or indefinite-life intangibles).

CONTRACT SERVICES. expense the costs of services performed by others in connection with the R&D as incurred.

Kohlbuy ten compares the implied value of the goodwill to the recorded goodwill to measure the impairment-MEASUREMENT OF GOODWILL IMPAIRMENT

Carrying amount of goodwill $900,000 Less: Implied value of goodwill 400,000 Loss on impairment $500,000

Calculation of Amortization Expense with Residual Value

Cost $6,000,000 Less: Residual Value 60,000 Amortization base: 5,940,000

IDENTIFY THE COSTS TO INCLUDE IN THE INITIAL VALUATION OF INTANGIBLE ASSETS. intangibles are recorded at cost.

Cost includes all acquisition costs and expenditures needed to make the intangible asset ready for its intended use.

companies RECORD AT COST intangibles purchased from another party.

Cost includes all acquisition costs plus expenditures to make the intangible asset ready for its intended use. Typical costs include purchase price, legal fees, and other incidental expenses.

DEVELOPMENT ACTIVITIES: 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.

Ex: conceptual formulation and design of possible product or process alternatives; construction of prototypes and operation of pilot plants.

Another type of franchise, granted by a governmental body, permits the business to use public property in performing its services.

Example are the use of city street for a bus line or taxi service; the use of public land for telephone, electronic, and cable television lines; and the use of airwaves for radio or TV broadcasting. Such operating rights are referred to as licenses or permits.

DESCRIBE THE ACCOUNTING FOR RESEARCH AND DEVELOPMENT AND SIMILAR COSTS. Shows typical costs associated with R&D activities and the accounting treatment accorded them. many costs have characteristics similar to R&D costs.

Examples are start-up costs, initial operating losses, and advertising costs. For the most part, these costs are expensed as incurred, similar to the accounting for R&D costs.

DETERMINATION OF IMPLIED VALUE OF GOODWILL

Fair Value of Pritt Division 1,900,000 Less: Net Identifiable assets (excluding goodwill)(2,400,000-900,000) 1500,000 Implied value of goodwill $400,000

The notes to the financial statements have additional detailed information.

Financial statements must disclose the total R&D costs charged to expense each period for which an income statement is presented.

The accounting for start-up costs is straightforward: Expense start-up costs as incurred. The profession recognizes that companies incur start-up costs with the expectation of future revenues or increased efficiencies.

However, to determine the amount and timing of future benefits is so difficult that a conservative approach--expensing these costs as incurred--is required.

in performing this RECOVERABILITY TEST, the company estimates the future cash flows expected from use of the asset and its eventual disposal.

If the sum of expected future net cash flows (undiscounted) is less than the carrying amount of the asset, the company would measure and recognize an impairment loss.

the franchisor, having developed a unique concept or product, protects its concept or product through a patent, copyright, or trademark or trade name. the franchisee acquires the right to exploit the franchisor's idea or product by signing a franchise agreement.

N/A

MATERIALS, EQUIPMENT, AND FACILITIES. Expense the entire costs, UNLESS THE ITEMS have ALTERNATIVE FUTURE USES (in other R&D projects or otherwise). if there are alternative future uses, carry the items as inventory and allocate as consumed, or capitalize and depreciate as used.

PERSONNEL. Expense as incurred salaries, wages, and other related costs of personnel engaged in R&D.

GOODWILL is measured as the excess of the cost of the purchase over the fair value of the identifiable net assets( less liabilities) purchased. Goodwill is therefore measured as a residual rather than measured directly.

That is why goodwill is sometimes referred to as a PLUG, a GAP FILLER, or a MASTER VALUATION ACCOUNT.

EXPLAIN THE PROCEDURE FOR AMORTIZING INTANGIBLE ASSETS. intangibles have either a limited useful life or an indefinite useful life. Companies amortize limited-life intangibles.

They do not amortize indefinite-life intangibles.Limited-life intangibles should be amortized by systematic charges to expense over their useful life.

EXPLAIN THE ACCOUNTING ISSUES RELATED TO INTANGIBLE-ASSET IMPAIRMENTS. impairment occurs when the carrying amount of the intangible asset is not recoverable. Companies use a recoverability test and a fair value test to determine impairments for limited-life intangibles.

They use only a fair value test for indefinite-life intangibles. Goodwill impairments require a two-step process. First, test the fair value of the reporting unit, then do the fair value test on implied goodwill.

if intangibles are acquired in exchange for stock or other assets, the cost of the intangible is the fair value of the consideration given or the fair value of the intangible received, whichever is more clearly evident.

When a company makes a "basket purchase" of several intangibles or a combination of intangibles and tangibles, it should allocate the cost on the basis of fair values.

The difficulties in accounting for R&D are 1. identifying the costs associated with particular activities, project, or achievements,

and 2. determining the magnitude of the future benefits and length of time over which a company may realize such benefits. because of these latter uncertainties, companies are required to expense all research and development costs when incurred.

ARTISTIC-RELATED INTANGIBLE ASSETS involve ownership rights to plays, literary works, musical works, pictures, photographs, and video and audiovisual material. Copyrights protect these ownership rights.A copyright is federally granted right that all authors, painters, musicians, sculptors,

and other artists have in their creations and expression. A copyright is granted for the life of the creator plus 70 years. it gives the owner or heirs the exclusive right to reproduce and sell an artistic or published work. Copyrights are not renewable.

A company should amortize the cost of a franchise (or license) with a limited life as an operating expense over the life of the franchise. it should not amortize a franchise with an indefinite life nor a perpetual franchise; the company should instead carry such franchises at cost.

annual payments made under a franchise agreement should be entered as operating expenses in the period in which they are incurred. These payments do not represent an asset since they do not relate to FUTURE RIGHTS to use the property.

IDENTIFY THE CONCEPTUAL ISSUES RELATE TO RESEARCH AND DEVELOPMENT COSTS. R&D costs are not in themselves intangible assets,

but R&D activities frequently result in the development of something a company patents or copyrights.

2. they are not financial instruments. Assets such as bank deposits, accounts receivable, and long-term investments in bonds and stocks also lack physical substance.

however, financial instruments derive their value from the right (claim) to receive cash or cash equivalents in the future. Financial instruments are not classified as intangibles.

indicate the Presentation of intangible assets and related items. On the balance sheet, companies should report all intangible assets other than goodwill as a separate item. Contra accounts are not normally shown.

if goodwill is present, it too should be reported as a separate item.On the income (statement),companies should report amortization expense and impairment losses in continuing operations.

INDIRECT COSTS

include a reasonable allocation of indirect costs in R&D costs, except for general and administrative cost, which must be clearly related in order to be included in R&D.

what exactly are intangible assets? Intangible assets have two main characteristics. they lack physical existence. tangible assets such as property, plant, and equipment have physical form.

intangible assets, in contrast, derive their value from the rights and privileges granted to the company using them.

Conceptually, 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 often called "the most intangible of the intangible assets" because it is identified only with the business as a whole. The only way to sell goodwill is to sell the business.

Two difficulties arise in accounting for R&D expenditures: (1) identifying the costs associated with particular activities, projects, or achievements, and (2) determining the magnitude of the future benefits and

length of time over which such benefits may be realized.Because of these latter uncertainties, the FASB has simplified the accounting practice in this area. COMPANIES MUST EXPENSE ALL RESEARCH AND DEVELOPMENT COSTS WHEN INCURRED.

EXPLAIN THE ACCOUNTING ISSUES FRO RECORDING GOODWILL. unlike receivables, inventories, and patents that a company can sell or exchange individually in the marketplace, goodwill can be identified only with the company as a whole. Goodwill is a "going concern" valuation and is recorded

only when an entire business is purchased.A company should not capitalize goodwill generated internally. The future benefits of goodwill may have no relationship to the costs incurred in the development of that goodwill. Goodwill may exist even in the absence of specified costs to develop it.

TECHNOLOGY-RELATED INTANGIBLE ASSETS relate to innovations or technological advances. Examples are patented technology and trade secrets granted by the U.S. Patent and Trademark Office.A PATENT gives the holder exclusive right to use, manufacture, and sell a product

or process for a period of 20 years without interference or infringement by other. The two principal kinds of patents are PRODUCT PATENTS, which cover actual physical products, and process patents, which govern the process of making products.

RESEARCH ACTIVITIES

planned search or critical investigation aimed at discovery of new knowledge. Ex: laboratory research aimed at discovery of new knowledge; searching for application of new research findings.

DESCRIBE THE TYPES OF INTANGIBLE ASSETS. Mayor types of intangibles are (1) marketing-related intangibles, used in the marketing or promotion of products or services; (2) customer-related intangibles, resulting from interactions with outside parties;(3) artistic-related intangibles, giving ownership

rights to such items as plays and literary works; (4) contract-related intangibles, representing the value of rights that arise from contractual arrangements; (5) technology-related intangibles, relating to innovations or technological advances; and (6) goodwill, arising from business combination.

if a company buys a trademark or trade name, it capitalizes the cost at the purchase price. if a company develops a trademark or trade name, it capitalizes costs related to securing it,

such as attorney fees, registration fees, design costs, consulting fees, and successful legal defense costs. However, it excludes research and development costs. When the total cost of a trademark or trade name is insignificant, a company simply expenses it.

The useful life should reflect the period over which these assets will contribute to cash flows.

the amount to report for amortization expense should reflect the pattern in which a company consumes or uses up the asset, if it can reliably determine that pattern. otherwise, use a straight-line approach.

to record goodwill, a company compares the fair value of the net tangible and identifiable intangible assets with the purchase price of the acquired business.

the difference is considered goodwill. Goodwill is the residual. Goodwill is often identified on the balance sheet as the excess of cost over the fair value of the net assets acquired.

INTERNALLY CREATED GOODWILL. GOODWILL GENERATED INTERNALLY SHOULD NOT BE CAPITALIZED IN THE ACCOUNTS. The reason? Measuring the components of goodwill is simply too complex, and associating any costs with future benefits is too difficult. the future benefits of goodwill may have no relationship

to the cost incurred in the development of that goodwill.To add the mystery, goodwill may even exist in the absence of specific costs to develop it. Finally, because no objective transaction with outside parties takes place, a great deal of subjectivity--even misrepresentation--may occur.