Intermediate Accounting II - Chapter 12
Accounting for R&D
1) Materials, equipment and facilities -Those with NO alternate use (it can only be used for this one project) => EXPENSE entire costs -Those that have ALTERNATE future use (it can be used for multiple projects) => carrying cost as inventory and allocate as consumed or capitalize and depreciate as used 2) Personnel -expense R&D costs such as salaries, wages and related costs are expensed as incurred 3) Purchased intangibles (purchased intangible from someone else) -Recognize and measure at FMV, and treat as intangibles as noted above 4) Contract services -Expense the cost of services performed by others as incurred 5) Indirect costs -Except for general and administrative costs, allocate a reasonable share of indirect costs of R&D expense Journal Entry: Debit: Research & Development Expense Credit: Cash (or various payables) **Amount = total R&D costs (made up of the above 5 costs)
Trademark (brand name) / trade name (company name)
A distinguishing word, phrase or symbol Ex: Amazon, Nike, "Just Do it" CFP (R), TM, Coca-Cola Registration with the US Patent and Trademark Office provides legal protection for a period of 10 years and can be renewed for an indefinite number of years **Becomes an indefinite life if you continue or plan to continue renewal**
Which of the following is NOT a characteristic of intangible assets?
All answer choices are characteristics of intangible assets -They are not financial instruments -They lack physical existence -They are classified as long-term assets
The cost of a purchased intangible asset includes
All of these answer choices are correct -Incidental expenses -Purchase price -legal fees
Limited life Contracts
Amortize the cost over the life of the contract
Indefinite-Life Intangibles
An intangible has an indefinite life when there are no legal, regulatory, contractual, competitive, or other factors that limit its useful life Since there is no apparent limit to the period of time over which the intangible can produce cash flows, it is NOT AMORTIZED Tested for impairment ANNUALLY **Only the fair value test is applied because cash flows could extend indefinitely and the asset would never fail the recoverability test**
Bramble Corporation obtained a franchise from Marin Inc. for a cash payment of $67,200 on April 1, 2020. The franchise grants Bramble the right to sell certain products and services for a period of 6 years. Prepare Bramble's April 1 journal entry and December 31 adjusting entry
April 1: Debit: Franchise $67,200 Credit: Cash $67,200 December 31: Debit: Amortization Expense $8,400 Credit: Franchise $8,400 *Amount = 67,200 x (1/6) x (9/12)
Limited-life Intangibles
Assets such as copyrights, patent, and licenses or permits with limited lives Amortize the cost of the intangible asset over its useful life Amortization expense should reflect the pattern in which the company consumes or uses up the asset *Otherwise amortization expense should be charged on a straight-line basis (similar to straight-line depreciation* Debit: Amortization Expense Credit: The intangible asset (directly) **Most firms credit the asset account directly rather than using an accumulated depreciation account** Tested for impairment REGULARLY, using a procedure similar to PP&E impairment testing
Indefinite Life Contracts
Capitalize the cost **NO amortization**
Research and Development (R&D) Costs
Expenditures that may lead to patents, copyrights, new processes, or new products. May lead to the development of intangibles, but NOT treated as intangible Research Activities = planned search or critical investigation aimed at discovering of new knowledge (developing/searching for idea) Examples: laboratory research aimed at discovery of new knowledge & searching for applications of new research findings 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 of use Examples: conceptual formulation and design of possible product or process alternative & construction of prototypes and operation of pilot plants **Does NOT include routine or periodic alterations/improvements to existing products, product lines, etc.**
Franchise Agreement Monthly or Annual Payments
Expensed as incurred Do NOT relate to future rights to use the property
A purchased indefinite-life intangible asset is not amortized and is impairment tested annually using the recoverability test followed by the fair value test
FALSE
An indefinite-life intangible asset is amortized over the shorter of it useful life or its legal life
FALSE
Impairment testing is performed in the same way for indefinite-life intangibles and limited-life intangibles
FALSE Indefinite-life intangibles: a company performs only the fair value test Limited-life intangibles: a company performs a recoverability test and then a fair value test
Intangible assets are normally classified as current assets
False In most cases, intangible assets provide services over a period of years and are therefore classified as long-term assets
Patent
Granted by the US Patent and Trademark Office Grants exclusive right to use, manufacture, and sell a product or process for 20 years **Expires at the end of 20 years** Two types: - Produce patents (physical products) [ex: computer] - Process patents (process of making products)
Internally Created Intangibles Valuation
Instead of purchasing an intangible asset, a company may create its own intangible (ex: it receives a patent for a new product or process it has developed) Most development costs are EXPENSED (ex: research and development costs) **Only direct costs incurred in the development of the asset (ex: legal costs and registration fees) are CAPITALIZED** Justified: - Non-direct costs incurred may bear no relationship to the intangible's real value - it may be difficult to associate an internal cost with a specific intangible - the underlying subjectivity of intangibles calls for a conservative approach
Cost of purchasing a copyright
Intangible asset
Cost of purchasing a patent from an inventor
Intangible asset
Cost of purchasing a trademark
Intangible asset
Goodwill acquired in the purchase of a business
Intangible asset
Legal costs incurred in securing a patent
Intangible asset
Purchase cost of a franchise
Intangible asset
Unrecovered costs of a successful legal suit to protect the patent
Intangible asset
Which of the following statements concerning intangible assets is correct?
Intangible assets derive their value from the rights and privileges granted to the company using them
Customer-Related Intangible Assets
Intangible assets that occur as a result of interactions with outside parties Arise from interactions with outside parties Examples: customer lists, order or production backlogs, contractual and non-contractual customer relationships Generally have a limited life and should be amortized Journal entry: -Record acquisition of intangible asset Debit: Intangible asset Credit: Cash -Record first year of amortization Debit: Amortization Expense (cost of intangible x 1/# of years of useful life) Credit: Intangible asset
Contract-Related intangible Assets
Intangible assets that represent the value of rights that arise from contractual arrangements. Examples: -Franchise -License or Permits -Limited Life Contracts -Indefinite Life Contracts -Franchise Agreement Monthly or Annual Payments Journal Entry: -Record the franchise agreement Debit: Franchise Credit: Cash -Record first year of amortization Debit: Amortization expense (cost of intangible assets x 1/# of years of useful life x partial year**if applicable**) Credit: Franchise
Marketing-Related Intangible Assets
Intangible assets used in the marketing or promotion of products or services. Examples: Trademark (brand name) or Trade name (company name) Valuation: - if it is acquired, capitalize the acquisition cost PLUS any costs to get it ready for its intended use (ex: legal fees) - if it is internally developed, only direct costs (such as legal costs or registration costs) are capitalized Amortization: If the company plans to renew the registration indefinitely, then there is NO amortization Journal entry: -Record purchase of intangible Debit: Trademark Credit: Cash -Record first year of amortization **If the company plans to renew the intangible it has an indefinite life, and therefore is not amortized** -Record first year of amortization (used only for x years) Debit: Amortization Expense (cost of intangible x 1/x yrs) Credit: Intangible asset
Goodwill
Intangible resources and elements of an entity that cannot be separately identified from the company as a whole Ex: management or marketing expertise, technical skill and knowledge, company reputation, name recognition, etc. Measuring and Recording: **Internally Created goodwill -It is extremely complex and too difficult to measure the costs of internally created goodwill (if any) and the future benefits associated with it -Therefore, internally created goodwill is NOT capitalized **Purchased goodwill -Because goodwill cannot be separated from or separately identified from a business, it is only recorded when an entire business is purchased -Purchased goodwill is measured as the excess cost of the purchase price of a business over the fair market value (FMV) of the net identifiable assets acquired **Goodwill = Purchase price - FMV of net identifiable assets** Other names for goodwill: Plug, gap filler, or master valuation account Calculation for net identifiable Assets: FMV of identifiable assets (FMV of identifiable assets) ------------------------------------ FMV of net identifiable assets Calculation for goodwill: Purchase price paid (cash AND notes payable) (FMV of net identifiable assets) ------------------------------------------------------ Goodwill recorded **make sure to put assets and liabilities on books at FAIR VALUE**
Purchased intangibles Valuation
Intangibles purchased from another party are recorded at their acquisition cost PLUS any expenditures required to make the intangible ready for its intended use (Ex: purchase price, legal fees, incidental expenses, etc.) If it is a nonmonetary exchange where the intangible is received in exchange for stock or other assets, then the intangible is valued at the fair value of the consideration given or the fair value of the intangible received, whichever is more clearly evident
Johan Co. has an intangible asset, which it estimates will have a useful life of 10 years, while Abco Co. has goodwill, which has an indefinite life. Which company should report amortization in its financial statements?
Johan: Yes; Abco: No According to ASC Topic 350, an intangible asset with a definite useful life should be amortized Goodwill is no longer amortized; it is tested for impairment
Intangible assets have two main characteristics that distinguish them from other assets
Lack physical substance & not financial instruments
Cost of conceptual formulation of possible product alternatives
Not an intangible asset
Cost of developing a patent
Not an intangible asset
Cost of developing a trademark
Not an intangible asset
Cost of engineering activity required to advance the design of a product to the manufacturing stage
Not an intangible asset
Cost of equipment obtained
Not an intangible asset
Cost of searching for applications of new research findings
Not an intangible asset
Costs incurred in the formation of a coporation
Not an intangible asset
Goodwill generate internally
Not an intangible asset
Investment in a subsidiary company
Not an intangible asset
Lease prepayment (6 months' rent paid in advance)
Not an intangible asset
Operating losses incurred in the start-p of a business
Not an intangible asset
Research and development costs
Not an intangible asset
Timberland
Not an intangible asset
Training costs incurred in start-up of new operation
Not an intangible asset
Long-term receivables
Not an intangible assets
Cost of testing in search for product alternatives
Not an intangibles asset
Technology-Related Intangible Assets
Related to innovations or technological advances Example: Patent Valuation: -if it is acquired, capitalize the acquisition cost plus any other costs to secure the patent (ex: legal fees) -if it is internally developed, only direct costs such as legal costs are capitalized (**All research and development costs are EXPENSED as incurred**) Amortization: - amortize over the cost over the shorter of the legal life or useful life (ex: the period in which benefits are received) Journal Entry: -Record acquisition of patent Debit: Patent Credit: Cash -Record first year of amortization Debit: Amortization expenses (cost of patent x 1/# of years of shorter of legal life or useful life) Credit: Patent
Presentation of Intangibles
Reporting is generally similar to reporting PP&E Balance Sheet: -Generally don't have contra accounts for intangibles on balance sheet -Intangible assets may be reported on the balance sheet in detail or in a condensed format with one line item for Goodwill and one line item for all other intangibles -Goodwill MUST be reported separately -Details of the intangible assets should be disclosed in the notes Income Statement: -Amortization expense is reported separately and as part of continuing operations -Impairment losses for intangible assets (other than goodwill) are reported separately and as part of continuing operations -Impairment losses for goodwill are reported separately and as part of continuing operations Financial Statement Notes: -information about acquired intangible assets -Aggregated amortization expense (amortization is recorded to date) for each succeeding 5 years - accumulated amortization - if separate contra accounts are not used - changes in carrying amount of goodwill during the period
Impairment of Goodwill
Review the assets AT LEAST ANNUALLY **Goodwill has an unlimited life, so you only use the fair value test** 1) Apply fair value (quantitative) test on reporting unit -Determine the fair value and carrying value of the unit (including goodwill) -If unit carrying amount > unit fair value = unit goodwill is impaired **Impairment = unit fair value - unit net identifiable assets (including goodwill)** 2) If value subsequently increases The impairment loss cannot be recovered under US GAAP 3) Optional Qualitative Assessment Similar to other indefinite life intangibles, a company may perform a qualitative assessment first to determine if the fair value test is needed Journal Entry: - Compute amount of goodwill recognized Acquisition price - FMV net identifiable assets = goodwill - Determine impairment loss FMV of net identifiable assets < carrying value of net assets = Impairment Impairment amount = carrying value - FMV of assets - Record impairment loss Debit: Loss on Impairment Credit: Goodwill **This loss will be reported in income as a separate line item before the subtotal "income from continuing operations" in a multiple=step income statement**
Impairment of indefinite-Life Intangibles (Other than Goodwill)
Review the assets at least annually The recoverability test is NOT used Many assets will easily meet the recoverability test because cash flows may extend for an extremely long period of time for indefinite intangibles 1) Only apply Fair value test -If asset carrying amount > asset fair value = asset is impaired **Impairment loss = asset carrying value - asset fair market value 2) If value subsequently increases The impairment loss cannot be recovered under US GAAP 3) Optional Qualitative Assessment -Before applying the fair value test, a company may first perform a qualitative assessment to try and save time and money if the asset is not impaired -Factors considered may include changes in general economic conditions, changes in the competitive environment, changes in the market for the company's products and services, regulatory or political factors, increases costs that negatively impact the company's earning, overall financial performance of the company, etc. -The fair value test is only required if the assessment determines that it is more likely than not (likelihood of more than 50%) that the intangible asset is impaired
Copyright
Right granted by the federal government that provides protection of rights to artistic-related intangibles Exclusive right to reproduce and sell the underlying artistic/published work Granted for the life of the creator plus 70 years NOT renewable **Pay owner of copyrighted material in order to use**
Impairment of Limited-Life Intangibles
Similar to PP&E as discussed in Chapter 11 Review the assets whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable 1) Apply Recoverability Test - Are estimated net future cash flows (undiscounted) LESS than the asset carrying amount? If yes, then impaired and apply the fair value test **Carrying value > net future cash flows = Impairment** 2) Apply Fair Value Test - Impairment loss = asset carrying value - asset fair market value 3) Amortization After recognizing impairment, the new carrying value becomes the basis for future amortization 4) if value subsequently increases The impairment loss cannot be recovered under US GAAP Journal Entry: -Record impairment of the asset Debit: Loss on Impairment Credit: limited-life intangible asset -Record amortization related to the intangible asset Debit: Amortization expense Credit: limited-life intangible asset **Amount = new carrying amount (aka. fair value) / useful life -Record an increase in fair value Debit: No Entry Credit: No Entry **Asset is held for use so you cannot write up for increase in fair value**
Costs similar to R&D Costs
Similar to R&D costs, the following costs are generally expensed when incurred: -Start-up costs for a new operation (organization costs) -Initial operating losses -Advertising costs -Computer software costs Journal Entry: Debit: Cost similar to R&D costs Credit: Cash (or various payable)
A company capitalizes only the direct costs incurred in developing an intangible, such as legal costs.
TRUE
The residual value of an intangible asset should be assumed to be zero unless, at the end of its useful life, the intangible asset has value to another company.
TRUE
Which of the following is NOT a characteristic of intangible assets?
They are all subject to amortization Characteristics of intangible assets: -They are not financial instruments -They are long-term in nature -They lack physical existence
Which of the following is a characteristic of intangible assets?
They are long-term in nature
Licenses or Permits
Type of franchise where a governmental entity allows the use of public property Ex: City streets for taxi/bus service, public land and airwaves for telephone, airwaves for broadcasting, etc.
Reversal of Impairment Loss
US GAAP: -Impairment loss CANNOT be reversed for assets that will be held and used -Impairment loss can be reversed for assets held for disposal IFRS: -Impairment loss can be reversed for assets that will be held and used -Impairment loss can be reversed for assets held for disposal
R&D costs
US GAAP: Costs in both research and development phase are expensed as incurred (both fully expensed) IFRS: -costs in the research phase are expensed as incurred (**research is FULLY EXPENSED**) -costs in the development phase of R&D are capitalized when technological feasibility (economic viability) is achieved) (**development can be CAPITALIZED**)
Revaluation of Limited-life Intangibles
US GAAP: Not permitted (Except impairment write-down) IFRS: Permitted
Cost of Internally Developed Intangibles
US GAAP: Only direct costs are capitalized (ex: legal costs and registration fees) IFRS: Costs related to some internally developed intangibles such as brand value can be capitalized if there is a probable future benefit and the amount can be reliably measured
Measurement of Impairment
US GAAP: The asset's carrying amount less its fair market value IFRS: -The asset's carrying amount less the recoverable amount -See textbook for how the recoverable amount is measured
Franchise
a contractual agreement where the franchisor grants the franchisee the exclusive right to sell certain products or services, use certain trademarks or trade names, or perform certain functions in a designated geographical region Ex: Dunkin Donuts, Starbucks, Seven-Eleven, Popeye's, Shell
Amortization of Intangibles
a systematic rational allocation of the cost of an intangible asset over its useful life Similar to depreciation for tangible assets
During 2016, Pronghorn Corporation Spent $161,280 in research and development costs. As a result, a new product called the New Age Piano was patented. The patent was obtained on October 1, 2016 and had a legal life of 20 years and a useful life of 10 years. legal costs of $36,720 related to the patent were incurred as of October 1, 2016.
a) Prepare all journal entries required in 2016 and 2017, as a result of the transactions above 2016 - Record research and development expenses Debit: Research and Development Expense $161,280 Credit: Cash $161,280 2016 - Record legal expenses Debit: Patent $36,720 Credit: Cash $36,720 2016 - Record amortization expense Debit: Amortization Expense $918 Credit: Patent $918 *Amount = 36,720 x (1/10) x (3/12) 2017: Debit: Amortization Expense $3,672 Credit: Patent $3,672 b) On June 1, 2018, Pronghorn spent $11,160 to successfully prosecute a patent infringement suit. As a result, the estimate of useful life was extended to 12 years from June 1, 2019. prepare all journal entries required in 2018 and 2019. 2018 - Record patents Debit: Patent $11,160 Credit: Cash $11,160 2018 - Record amortization expense Debit: Amortization Expense $3,560 Credit: Patent $3,560 2019 Debit: Amortization Expense $3,480 Credit Patent $3,480
Kingbird, Inc., spent $36,000 in attorney fees while developing the trade name of its new product, the Mean Bean machine. Prepare the journal entries to record the $36,000 expenditures and the first year's amortization, using a 6-year life. Use the account title "trade Names"
a) Record expenditure of trade names Debit: Trade Names $36,000 Credit: Cash $36,000 b) Record amortization expenses Debit: Amortization Expense $6,000 Credit: Trade Names $6,000 *Amount = 36,000 / 6
Lack physical substance
derive their value from the rights and privileges the company receives for owning them Cannot touch or feel them **Provide value and privileges to the company
Not financial instruments
financial instruments such as account receivable and investments in stocks and bonds also lack physical substance, but they represent rights or claims to receive cash in the future
Artistic-Related Intangible Assets
involve ownership rights to plays, literary works, musical works, pictures, photographs, and video and audiovisual material Examples: Copyright Valuation: - If it is acquired, capitalize the acquisition cost plus any costs to get it ready for its intended use (Ex: legal fees) - if it is internally developed, only direct costs such as legal costs are capitalized Amortization: Amortize over the amount of time the company expects to receive benefits from the copyright
A purchase limited-life intangible asset _____ amortized and is impairment tested using ______
is; the coverability test and then the fair value test
Legal defense costs
legal costs incurred to successfully defend rights to an intangible asset are capitalized (**if you win the legal suit**) Any new costs capitalized are amortized over the remaining life of the asset If the defense is NOT successful, the legal costs are EXPENSED Journal Entry: -Record legal fees assuming defense was not successful Debit: Legal expense Credit: Cash -Record legal fees assuming defense was successful Debit: Patent Credit: Cash -Record amortization for fourth year Debit: Amortization expense Credit: Patent **Amount: cost of intangible asset - (years passed x amortization per year)
Amortization & Impairment of purchased goodwill
treated as if it has an INDEFINITE life **therefore, NOT amortized** is tested for impairment and written down if impaired
