ACCO 3001 chapter 11.pptx
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ACG 3001 Intermediate Accounting Chapter 11: Intangible Assets Learning Objectives Learning Objective Topics Examples LO 11.1 Discuss the characteristics, valuation, and amortization of intangible assets. 11.1 Intangible Asset Issues Examples 11.1 Amortization of a License 11.2 Amortization...
ACG 3001 Intermediate Accounting Chapter 11: Intangible Assets Learning Objectives Learning Objective Topics Examples LO 11.1 Discuss the characteristics, valuation, and amortization of intangible assets. 11.1 Intangible Asset Issues Examples 11.1 Amortization of a License 11.2 Amortization of a Brand 11.3 Impairment of a Patent 11.4 Accounting for a Trademark 11.5 Impairment of a License LO 11.2 Discuss the accounting and financial statement presentation for various types of intangible assets. 11.2 Types and Presentation of Intangibles Marketing-related Customer-related Artistic-related Contract-related Technology-related Presentation Examples 11.6 Trademark 11.7 Customer List 11.8 Residual Value—Customer List 11.9 Copyright 11.10 Broadcast License 11.11 Patent LO 11.3 Explain the accounting issues for recording goodwill. 10.3 Depletion Establishing a base Cost allocation Estimating reserves Liquidating dividends Continuing controversy Examples 10.12 Depletion Cost per Unit 10.13 Liquidating Dividend LO 11.4 Describe the accounting and presentation for research and development and similar costs. 11.4 Research and Development Costs Identifying R&D Accounting for R&D Similar costs Presentation Examples 11.14 Start-Up Costs 11.15 Initial Operating Losses Characteristics Valuation Accounting Intangible Asset Issues Characteristics Valuation 1. Lack physical existence. Purchased Intangibles 2. Not financial instruments. • Recorded at cost Normally classified as long-term asset. • Includes all costs necessary to make the intangible asset ready for its intended use Common types of intangibles: • Typical costs include: • Patents Purchase price • Copyrights Legal fees • Franchises or licenses Other incidental expenses • Trademarks or trade names Internally Created Intangibles • Goodwill • Recorded at cost • Generally expensed • Only capitalize direct costs incurred in developing intangible, such as legal costs 3 Amortization of Intangibles Limited-Life Intangibles • Amortize to expense over useful life • Credit asset account or accumulated amortization • Useful life should reflect the periods over which the asset will contribute to cash flows • Amortization should be cost less residual value • Companies should evaluate the limitedlife intangibles for impairment LO 1 Indefinite-Life Intangibles • No foreseeable limit on time the asset is expected to provide cash flows • Must test indefinite-life intangibles for impairment at least annually • No amortization International Perspective IFRS requires capitalization of some development costs. 4 Amortization of Intangibles Manner Acquired Type of Intangible Limited-life intangibles Indefinite-life intangibles Purchased Capitalize Internally Created Expense* Impairment Amortization Test Over useful Recoverability life test and then fair value test Capitalize Expense* Do not amortize Fair value test only * Except for direct costs, such as legal costs. LO 1 5 Types of Intangible Assets Six Major Categories: 1. Marketing-related. 2. Customer-related. 3. Artistic-related. 4. Contract-related. 5. Technology-related. 6. Goodwill. 6 Types of Intangible Assets Marketing-Related Intangible Assets • Examples: Trademarks or trade names, newspaper mastheads, Internet domain names, and non-competition agreements • U.S. - Indefinite number of 10 year renewal periods • Capitalize acquisition costs • No amortization Hatley Company acquired a trademark, which cost $3 million, that will help the company to better identify and distinguish one of its consumer products in the market. The trademark has a remaining life of 8 years and is renewable at a minor cost every 10 years. Numerous internal studies have indicated that this trademark will provide substantial cash flows to Hatley for an indefinite period. What entries do you think Hatley should make in the first year? 7 Customer-Related Intangible Assets • Examples: Customer lists, order or production backlogs, and both contractual and noncontractual customer relationships • Capitalize acquisition costs • Amortized to expense over useful life Illustration: Green Market Inc. acquires the customer list of a large newspaper for $6,000,000 on January 1, 2020. Green Market expects to benefit from the information evenly over a three-year period. Record the purchase of the customer list and the amortization of the customer list at the end of each year. Jan. 1, 2017 Dec. 31 2017 2018 2019 LO 2 Customer List Cash 6,000,000 Amortization Expense 2,000,000 Customer List * * or Accumulated Amortization 6,000,000 2,000,000 8 Artistic-Related Intangible Assets • Examples: Plays, literary works, musical works, pictures, photographs, and video and audiovisual material • Copyright granted for the life of the creator plus 70 years • Capitalize costs of acquiring and defending • Amortized to expense over useful life Contract-Related Intangible Assets • Examples: Franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts • Franchise (or license) with a limited life should be amortized to expense over the life of the franchise • Franchise with an indefinite life should be carried at cost and not amortized LO 2 9 Technology-Related Intangible Assets • Examples: Patented technology and trade secrets granted by the U.S. Patent and Trademark Office • Patent gives holder exclusive use for 20 years • Capitalize costs of purchasing a patent • Expense any R&D costs in developing a patent • Amortize over legal life or useful life, whichever is shorter Illustration: Harcott Co. incurs $180,000 in legal costs on January 1, 2020, to successfully defend a patent. The patent’s useful life is 12 years, amortized on a straight-line basis. Harcott records the legal fees and the amortization at the end of 2020 as follows. Jan. 1 Patents Cash 180,000 15,000 Dec. 31 Amortization Expense Patents (or Accumulated Amortization) 180,000/12 years LO 2 180,000 15,000 10 Goodwill Represents the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized. Only recorded when an entire business is purchased. Goodwill is the ... excess of cost of the purchase over the FMV of the identifiable net assets (assets less liabilities) purchased. Internally created goodwill should not be capitalized. Example #1: Multi-Diversified, Inc. decides that it needs a parts division to supplement its existing tractor distributorship. The president of Multi-Diversified is interested in buying Tractorling Company. The illustration presents the statement of financial position of Tractorling Company. 11 Multi-Diversified investigates Tractorling’s underlying assets to determine their fair values. Cash Accounts receivable Inventory Property, plant, and equipment, net Patents Liabilities Fair value of net assets $ 25,000 35,000 122,000 205,000 18,000 (55,000) $350,000 Tractorling Company decides to accept Multi-Diversified’s offer of $400,000. What is the value of the goodwill, if any? Diversified records this transaction as follows. Cash Accounts Receivable Inventory Property, Plant, and Equipment Patents Goodwill Liabilities Cash 25,000 35,000 122,000 205,000 18,000 50,000 55,000 400,000 12 Example #2: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2020. The balance sheet of Local Company just prior to acquisition is: Assets Cash Receivables Inventories Equipment Total Cost $ 15,000 10,000 50,000 80,000 $155,000 FMV $ 15,000 10,000 70,000 130,000 $225,000 Liabilities and Equities Accounts payable Common stock Retained earnings Total $ 25,000 100,000 30,000 $155,000 $25,000 Journal entry recorded by Global: FMV of Net Assets = $200,000 Cash Receivables Inventories Equipment Accounts payable FMV of identifiable net assets Purchase price Goodwill $ 15,000 10,000 70,000 130,000 (25,000) 200,000 300,000 $100,000 15,000 Cash 10,000 Receivables Inventory 70,000 130,000 Equipment Goodwill 100,000 25,000 Accounts Payable 300,000 Cash 13 Goodwill Goodwill Write-Off • Goodwill considered to have an indefinite life = Should not be amortized • Only adjust carrying value when goodwill is impaired Bargain Purchase • Purchase price less than the fair value of net assets acquired • Amount is recorded as a gain by the purchaser P1 14 Impairment of Limited-Life Intangibles Same as impairment for long-lived assets in Chapter 10. 1. If the sum of the expected future net cash flows (undiscounted) is less than the carrying amount of the asset, an impairment has occurred (recoverability test). 2. The impairment loss = Carrying Amount – Fair Value of the asset (fair value test). The loss is reported as part of income from continuing operations, “Other expenses and losses” section. Illustration: Perform the fair value test and the journal entry (if any) to record the impairment of the asset. Carrying amount of patent $60,000,000 Less: Fair value (based on present value computation) Loss on impairment 20,000,000 $40,000,000 Lerch records this loss as follows. Loss on Impairment 40,000,000 Patents 40,000,000 Companies may not recognize restoration of the previously recognized impairment loss. 15 Impairment of Indefinite-Life Intangibles Other than Goodwill • Should be tested for impairment at least annually • Impairment test is a fair value test (one step process) If fair value of asset is less than carrying amount, an impairment loss is recognized for the difference Recoverability test is not used Impairment of Goodwill If the fair value of the reporting unit (including goodwill) is less than the carrying value of the reporting unit (including goodwill), there is an impairment loss. If the fair value of the reporting unit (including goodwill) is greater than the fair value of the reporting unit (including goodwill), there is no impairment. 16 Impairment of Goodwill: Kohlbuy Corporation purchased one division, Pritt Products, four years ago for $2 million. Kohlbuy management is now reviewing the division for purposes of recognizing an impairment. This illustration lists the Pritt Division’s net assets, including the associated goodwill of $900,000 from the purchase. Cash Accounts receivable Inventory Property, plant, and equipment (net) Goodwill Accounts and notes payable Net assets $ 200,000 300,000 700,000 800,000 900,000 (500,000) $2,400,000 Assume the fair value of Pritt Division is $1,900,000. Illustration: Prepare the journal entry (if any) to record the impairment. Step 1: The fair value of the reporting unit is below its carrying value. Therefore, an impairment has occurred. Fair value Step 2: $1,900,000 Less: Net Identifiable assets (including goodwill) Loss on impairment Loss on Impairment Goodwill 2,400,000 $ (500,000) 500,000 500,000 17 Impairment of Intangible Assets Summary Balance Sheet • Intangible assets shown as a separate item • Goodwill is separated from other intangibles • Reporting is similar to reporting of property, plant, and equipment • Intangible assets shown as a separate item, but net of contra accounts Income Statement • Report amortization expense and impairment losses in continuing operations • Goodwill impairment losses should be presented as a separate line item in the continuing operations section, unless goodwill impairment is associated with a discontinued operation LO 4 18 Research and development (R&D) costs are not in themselves intangible assets. Research -> coming up with new knowledge Development -> taking new knowledge and turning it into a product Frequently results in something that a company patents or copyrights such as: • new product, Companies must • process, expense all research and • idea, development costs when • formula, incurred. • composition, or • literary work. Accounting for R&D Activities Costs Associated with R&D Activities and what to do with them: • 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 • Purchased Intangibles – part of intangible. Recognize and measure it at fair value. • Contract Services - expense 19 • Indirect Costs – include a reasonable allocation in R&D costs Research and Development Costs Identifying R&D Activities LO4 Research and Development Costs Exercise 11.1 (Items 1-6) Indicate how items on the list below would generally be reported in the financial statements. Item Classification 1. Investment in a subsidiary company. 1. Long-term investments 2. Timberland. 2. PP&E 3. Cost of engineering activity required to advance the design of a product to the manufacturing stage. 3. R&D expense 4. Lease prepayment (6 months paid in advance. 5. Cost of equipment obtained. 6. Cost of searching for applications of new research findings. 4. Prepaid rent 5. PP&E 6. R&D expense LO4 Research and Development Costs Exercise 11.1 (Items 7-12) Indicate how items on the list below would generally be reported in the financial statements. Item 7. Cost incurred in the formation of a corporation. 8. Operating losses incurred in the start-up of a business. 9. Training costs incurred in start-up of new operation. 10. Purchase cost of a franchise. Classification 7. Expense 8. Operating loss 9. Expense 10. Intangible 11. Not recorded 12. R&D expense 11. Goodwill generated internally. 12. Cost of testing in search of product alternatives. LO4 Research and Development Costs Exercise 11.1 (Items 13-17) Indicate how items on the list below would generally be reported in the financial statements. Item Classification 13. Goodwill acquired in the purchase of a business. 14. Cost of developing a patent. 15. Cost of purchasing a patent from an inventor. 16. Legal costs incurred in securing a patent. 13. Intangible 14. R&D expense 15. Intangible 16. Intangible 17. Intangible 17. Unrecovered costs of a successful legal suit to protect the patent. LO4 Research and Development Costs Exercise 11.17 Compute the amount to be reported as research and development expense. Cost of equipment acquired that will have alternative uses in future R&D projects over the next 5 years. Materials consumed in R&D projects Consulting fees paid to outsiders for R&D projects Personnel costs of persons involved in R&D projects Indirect costs reasonably allocate to R&D projects Materials purchased for future R&D projects Total R&D Expense *280,000 $280,000 R&D Expense *$56,000 59,000 100,000 128,000 50,000 34,000 59,000 100,000 128,000 50,000 $393,000 ÷ 5 = $56,000 LO4
