Chapter 11: Intangible Assets

What are the most important characteristics for many companies that are also intangible in nature?

• Image/brand

• Subscriber lists

• Secret formulas

What are intangible assets?

• Lack of physical existence

• The only evidence might be a document (e.g., patent)

• They aren’t financial instruments

What has the valuation of intangibles been?

Controversial

What does GAAP require for intangibles?

• Purchased intangibles be capitalized

• Internal R&D be expensed

How might the difference in accounting treatment affect managerial decision making?

If you buy the asset and slowly expense it over time, that may benefit net income

Many public firm CEOs feel pressure to meet/beat analyst forecasts, how might this affect investment in innovation?

If we invest in it today, we have to bear the expense right now, and we may not be able to see the benefit for many years

What did Berstein’s research find?

The quality of internal innovation declines following the IPO, and skilled investors leave the firm. However, public firms attract new human capital and acquire external innovation

What happens to the cost of a limited-life intangible asset?

It is amortized to expense over its useful life

What should the useful life reflect?

The periods over which the asset will contribute to cash flows

What are useful life factors considered?

• Expected use of the asset

• Expected useful life of other assets for which this intangible asset may relate

• Any provisions that enable a renewal or extension of the intangible

• Expected obsolescence

• Degree of additional expenditure that might be required to maintain the intangible asset’s value

What should the amount of amortization expense for limited-life intangible assets report?

The pattern in which the company consumes or uses up the asset (typically, a company uses straight-line)

What are subsequent expenditures?

If a company must spend money to defend an intellectual property like a patent

When are costs incurred to the Patents account?

If a company charges all unrecovered legal fees and other costs in successfully defending a patent suit

When should companies review limited-life intangibles for impairment?

Whenever events or changes indicate that the carrying amount of the asset may not be recoverable

What are indefinite-lived intangible assets?

Trademarks, trade names, perpetual franchises, and goodwill

What does an indefinite life mean?

There is no foreseeable limit on the period of time over which the intangible asset is expected to provide cash flows

Does a company amortize an intangible asset with an indefinite life?

No

When should companies test indefinite-life intangibles for impairment?

At least annually

What is the impairment test?

Only a fair value test:

• If the carrying value is less than the fair value, there is no impairment

• If the carrying value is more than the fair value, then there is an impairment for the difference

What may companies do to determine whether it is more likely than not that an indefinite-life intangible is impaired?

An optional qualitative assessment

What are the factors considered in an optional qualitative assessment?

• Competition

• Macro Economy

• Regulatory Developments

• Negative Financial Performance

What is Goodwill?

Represents the unique value of a company as a whole over and above its identifiable tangible and intangible assets

Where can Goodwill emerge from?

A company’s:

• Clientele and reputation

• Trained employees and management team

• Favorable business location

How does a buyer acquire Goodwill?

Because goodwill can’t be separated from a company, the buyer has to acquire the whole company or a portion of it as well

How do you find the Capitalized Cost of Goodwill?

Fair Value of the Consideration Exchanged (acquisition price) for the company - Fair Value of the Net Assets Acquired

How do you find the Fair Value of Net Assets Acquired?

Fair Value of Identifiable Assets Acquired - Fair Value of Liabilities Assumed

What is the debate about accounting for Goodwill?

Whether goodwill as an asset has an indefinite lifespan subject to periodic impairments tests (current GAAP), or a finite lifespan that companies should amortize just like PPE?

What do opponents point out about the impairment model?

Goodwill impairments do not provide useful information because they are a lagging indicator

Why do some investors prefer the impairment model?

Goodwill impairments can provide investors with relevant information (primarily when it’s company-specific info unanticipated by the market), and a goodwill asset on the balance sheet (subject to impairment) holds management accountable for its acquisitions

How has the impairment testing model been improved?

Impairments are reported more timely (better disclosures that include quantitative info on how an acquisitions performs over time)

Unlike other assets, what is different about the cost of Goodwill?

• Can’t be directly associated with any specific identifiable right, and

• It is not separable from the company as a whole

Can the impairment of Goodwill be measured in the same way as other long-lived assets?

No

What is the level of testing?

The reporting unit

What is a reporting unit?

An operating segment of a company or a component of an operating segment for which discrete financial info is available and segment management regularly reviews the operating results of that component

How do you measure Goodwill Impairment?

If the fair value of the reporting unit < book value, then impairment is necessary

What can the impairment loss of Goodwill not be?

Greater than the balance in the goodwill account

What happens if goodwill is tested for impairment at the same time as other assets of the reporting unit?

The other assets are tested first (and impaired if necessary)

What is Research?

Planned search or critical investigation to discover new knowledge that helps develop a new product or service or a new process or technique or improving an existing product or processes

What is Development?

Translation of research findings into a plan or design for a new product or process or improving existing product or processes, whether intended for sale or use

What does determining R&D costs include?

• Salaries, wages, and other labor costs of R&D personnel

• Cost of materials consumed, equipment, facilities, and intangibles used in R&D projects

• Costs of services performed by others

• A reasonable allocation of indirect costs related to the R&D activities

What costs are considered R&D?

• Cost of asset purchased for single R&D project

• Depreciation & amortization of asset purchased for more than a single R&D project

What are the three exceptions to the general expense research and development costs rule?

1. Software development costs

2. R&D performed by the company for others

3. R&D acquired in a business acquisition