Ch 11: Intangible Assets

Intangible Assets

1) Lack physical form (patent, copyrights etc;). Derive their value from the rights and prevliges granted to the company using them

2) Not financial instruments: they derive their value from rights and privileges, not from a right to receive cash

- long term

Valuation of Intangible Assets

- record intangibles purchased from another company at cost

- when they are given in exchange for stocks 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.

Limited Life Intangibles

- cost is amortized to expense over its useful life

Impairment of Limited Life Intangibles

- same as with PPE

1. Recoverability test.

- expected future cash flows > carrying value = no impairment.

- expected future cash flows < carrying value = impairment loss

If the conclusion is impairment, the company continues to the fair value test.

2. Fair Value Test.

CV - FV = Impairment Loss

- the loss on the limited-life intangible is reported as part of income from continuing operations. The loss is generally reported in the "Other expenses and losses" section of the income statement.

indefinite-Life Intangibles

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

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

- company does not amortize an intangible asset with an indefinite life.

Impairment of Indefinite-Life Intangibles

- only a fair value test:

CV < FV = No Impairment

CV > FV = Impairment Loss Recorded for the Difference

- only do one step bc many indefinite-life assets might never fail the recoverability test, as cash flows may extend many years into the future.

- Qualitive Assessment Factors:

- Deterioration of general economic conditions.

- Increased competitive environment.

- Change in the market for a company's products or services.

- Regulatory or political developments.

- Overall financial performance such as negative or declining cash flows.

If the qualitative assessment indicates that the asset is not impaired, the company need not continue with the fair value test. As a result, use of the qualitative assessment should reduce both the cost and complexity of performing the impairment test.

6 Types of Intangibles

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. Crypto-related intangible assets.

Marketing-Related Intangible Assets

- used in the marketing/promotion of products or services

- Trademark/Tradename: word/phrase/symbol that distinguishes or identifies a particular company or product

Customer-Related Intangible Assets

- result from interactions with outside parties.

- customer lists, order or production backlog, contractual and noncontractual customer relationships

Artistic-Related Intangible Assets

- ownership rights to plays, literary works, musical works, pictures...

- copyrights: federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations and expressions.

Contract-Related Intangible Asset

- represent the vale of rights that arise from contractual agreements

- franchise: contractual arrangement under which the franchisor 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.

Technology-Related Intangible Assets

relate to innovations or technological advances

- patent: gives the holder the exclusive right to use, manufacture, and sell a product or process for a period of 20 yrs without interference or infringement by others

Crypto-Related Intangible Assets

- crypto: digital money

Presentation of Intangible Assets on BS

- The reporting of intangible assets is similar to the reporting of PPE. However, contra accounts are not normally shown for intangibles on the balance sheet.

- On the income statement, companies should present amortization expense and impairment losses for intangible assets separately and as part of continuing operations

- The notes to the financial statements should include information about acquired intangible assets, including the aggregate amortization expense for each of the succeeding five years. If separate accumulated amortization accounts are not used, accumulated amortization should be disclosed in the notes.

- Because of the unusual nature of crypto assets, they are reported separately from other intangible assets on the balance sheet. Generally crypto assets are reported as a non-current asset except when it is likely that the crypto assets will be sold in the next year.

- Unrealized gains and losses on crypto assets are recorded separately from other impairments of intangible assets on the income statement. In addition, disclosures are required including significant crypto holdings as well as a reconciliation of the beginning and ending balances of crypto assets.

Business Combination

the purchase of another business

Goodwill

measured as the excess of the cost of the purchase over the fair value of the identifiable net assets (assets less liab) purchased

- the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized

- the only way to sell goodwill is to sell the business

Internally Recording Goodwill

- goodwill generated internally should not be capitalized in the accounts

-

Purchased Goodwill

- goodwill is recorded only when the entire business is purchases

- a company compares the FV of the net intangible and identifiable assets with the purchased price of the acquired business

- the difference is goodwill

- goodwill is the residual: the excess of cost over the FV of the identifiable net assets acquired

Impairment of Goodwill

- goodwill has an indefinite life and should not be amortized

- companies adjust the CV only when its impaired

- FV of the reporting unit (including goodwill) < CV of the reporting unit (including goodwill) = Impairment Loss

- FV of the reporting unit (including goodwill) > CV of the reporting unit (including goodwill) = No impairment

Bargain Purchase

- purchaser in a business combo pays less than the FV of the identifiable net assets

- seller would have been better off the sell the assets individually than in total

- excess amount is recorded as a gain by the purchaser

Presentation of Goodwill

- On the income statement, companies should present goodwill impairment losses as a separate line item in the continuing operations section, unless the goodwill impairment is associated with a discontinued operation.

- The notes to the financial statements should include information about changes in the carrying amount of goodwill during the period.

Research and Development Costs

- not in themselves intangible assets.

- but 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.

- must be expensed when incurred

Identifying R&D Activities

- Research Activities: Planned search or critical investigation aimed at discovery of new knowledge

- 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

The costs associated with R&D activities and the accounting treatments

1. Materials, equipment, and facilities. Expense the entire cost, 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 them as consumed, or capitalize and depreciate as used.

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

3. 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.

4. Contract services. Expense the costs of services performed by others in connection with the R&D as incurred.

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

Costs Similar to R&D Costs

1. Start-up costs for a new operation

2. Initial operating losses

3. Advertising costs

4. Computer software costs

Start-up Costs

- incurred for one-time activities to start a new operation

- include organization costs like legal fees and state fees

- expense as incurred

Initial Operating Losses

should not be capitalized

Advertising Costs

- expense as incurred or the first time advertising takes place

Computer Software Costs

companies exclude from the definition of R&D activities the acquisition, development, or improvement of a product or process for use in their selling or administrative activities. For example, the costs of software incurred by an airline in improving its computerized reservation system or the costs incurred in developing a company's management information system are not research and development costs but should be reported as selling and administrative expenses.

Presentation of R&D Costs

Companies should disclose in the financial statements (generally in the notes) the total R&D costs charged to expense each period for which they present an income statement.