Chapter 13: Intangible Assets and Goodwill

13-1 Identify and classify intangible items

• intangible assets: Assets (not including financial assets) that lack physical substance.

• Goodwill: an asset representing the future economic benefits arising from other assets acquired in a business combination … that are not individually identified and separately recognized.

Common Intangible Assets

• patent

  • exclusive right recognized by law and registered with the U.S. Patent Office

  • Enables the holder to use, manufacture, sell, and control the item process, or activity covered by the patent without interference by others.

• copyright

  • form of protection given by law to the authors of literary, musical, artistic, and similar works.

  • includes the right to print, reprint, sell, or distribute copies, and to perform and record the work

• trademark

  • name, symbol, or other distinctive identity given to a company, product, or service

• customer list

  • compilation of customer information including names and contact information

• franchise

  • granted by a franchisor for the right to use a particular name and offer specified services/products.

  • also granted by government entities for the right to use public properties or to furnish public services

• licenses

  • contractual operating rights often granted by a governmental body

• goodwill

  • arises when a company acquires another company and the purchase price exceeds the fair value of the identifiable net assets acquired in the purchase

  • although goodwill may be developed internally, it is not recognized unless a company is purchased

Useful Life of Intangibles

• patent : Legal life of 20 years or shorter estimated useful life

• copyright: life of the author plus 70 years or shorter estimated useful life

• customer list: indefinite or shorter estimated useful life

• Franchise, trademark, license: renewable indefinitely or shorter estimated useful life

• goodwill: indefinite

Assets Acquired in Business Combination

• while intangible assets may be acquired individually or with a group of other assets, intangible assets also may be acquired in a business combination or when one company purchases another company

• identifiable assets: are assets that arise from contractual or legal rights or are separable (capable of being separated from the company and sold, transferred, or exchanged)

• identifiable assets recorded at fair value

  • license agreements

  • franchise agreements

  • patents

  • acquired in-process research and development

    • relates to intellectual property purchased that is part of incomplete research and development projects and is recorded initially as an indefinite intangible asset until the project is complete

• excess paid over fair value of identifiable net assets

  • goodwill

Recognition of Expenses: Internally Generated Intangible Assets and Goodwill

• costs to develop intangible assets internally are generally expensed as incurred

• This means a patent acquired from a third party is recognized as an intangible asset, while costs incurred within a company to develop are expensed.

Internally Generated Intangibles

• expense as incurred including:

  • salaries paid to a company’s engineers for patent development

  • salaries paid to in-house counsel for a patent registration

Advertising

• expense as incurred or

• expense the first time advertising takes place with the following exception:

  • advertising cost incurred after related revenues are recognized when related revenues are recognized

• current accounting practices generally classify cryptocurrency as an intangible asset with an indefinite life

13-2 Determine the initial and subsequent measurements of finite life intangible assets

Initial Measurement

• Current cash-equivalent cost

  • includes purchase price, transfer and legal fees, and other costs to bring asset to its condition and location for intended use

• noncash consideration received

  • measure at fair value of the noncash consideration given or fair value of intangible received, whichever is more reliably measurable

• basket purchase

  • value according to each intangible’s fair value relative to the group

Subsequent Measurement

• finite useful life

  • allocate cost to expense in a rational and systematic manner over shorter of legal life or useful life

  • straight-line method used unless another method is more appropriate

    • Dr. amortization Expense #

    • Cr. Intangible Asset

    • #

13-3 Account for impairment and derecognition of finite life intangible assets

Impairment of Finite Life Intangible Asset

• Indicator Present

  • Identify an event or circumstance indicating asset may not be recoverable

• Step 1: Recoverability test

  • Compare undiscounted future net cash flows to carrying value

• Step 2: Impairment test

  • compare fair value to carrying value

  • measure impairment as excess of carrying value over fair value

Derecognition of Intangibles

• Upon disposal of intangible

  • Amortize asset (if applicable) up to the date of disposal

  • remove carrying value from the accounts

  • recognize gain or loss in disposal

  • report as a component of continuing operations

13-4 Account for change in estimates in finite life intangible assets

• change in residual value, useful life

• prospective treatment

• no change to prior reporting

• compute carrying value of the intangible asset at the date of change

• compute updated annual amortization expense considering the change in residual value and/or useful life

13-5 Determine the initial measurement of indefinite life intangible assets and goodwill

Indefinite Life Intangible Assets

• initially recorded at cost

• evaluate for impairment but do not amortize

Goodwill

• Company acquires control of another company

• Purchase price> fair value of identifiable net assets acquired

• Arises from favorable characteristics that benefit the company’s operations and future revenue streams, such as:

  • superior management team

  • outstanding sales organization

  • effective advertising

  • secret manufacturing process

  • exceptional reputation for total quality

  • A highly advantageous strategic location

Accounting for Goodwill

• Recorded only at the time of purchase of control of another company

• must be presented as a separate line item on the balance sheet

• test for impairment but do not amortize

FV of Net Identifiable Assets = Total Assets at Fair Value - Total Liabilities*

*if valued at carrying amount

13-6 Account for impairment of indefinite life intangible assets and goodwill

Impairment Testing of Indefinite Life Intangible Assets

• Impairment testing

  • test at least annually

  • may bypass qualitative test and move directly to quantitative test

• Step 1: Qualitative test

  • If a review of qualitative factors indicates that it is more likely than not that the asset is impaired, move to Step 2

• Step 2: Quantitative test

  • compare fair value to carrying value

  • measure impairment as any excess of carrying value over fair value

Impairment Testing of Goodwill

• Step 1: Qualitative Assessment

  • Test at least annually

  • May bypass qualitative test and move directly to quantitative test

• Step 2: Quantitative test

  • compare fair value to carrying value

  • measure impairment as any excess of carrying value over fair value (not to exceed amount of allocated goodwill)

13-7 Account for research and development costs

Research: is planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or a new process or in bringing about a significant improvement or an existing product or process.

Development: is the translation of research findings or other knowledge into a plan or design for a new product or process, whether intended for sale or use.

Examples of Non-R&D Expenses

• Routine or periodic alterations to existing products, lines, and processes

• General & administrative costs not clearly related to R&D

• Generally expense R&D as incurred

• Generally expense R&D as incurred

• Recognize as assets:

  • Materials, equipment, facilities, and intangibles with alternative future uses

  • computer software development costs when technological feasibility is reached

• disclose R&D expense in the notes to the financial statements

R&D Expense Incurred Before Commercial Production

• Pre-commercial production: Recognize R&D expense

• Commercial production: Begins when components meet basic functional and economic requirements for sale or use

• Post- commercial production: Recognize operating expense

Accounting for Software R&D Costs Developed Internally and Sold

• Pre-technological feasibility: Costs to establish technological feasibility of software product considered R&D

• Technological feasibility: Planning, designing, coding, and testing completed to establish that software can be manufactured to meet design specs evidenced by completion of (1) detailed program design or (2) working model

• Post-technological feasibility: Once technological feasibility is established, subsequent costs to obtain product master are capitalized as intangible asset

• capitalized software costs are amortized to expense on a product-by-product basis.

• amortization commences when the product begins to be marketed

• The annual amortization is the greater of the amount measured through the revenue method or the straight line method

Revenue method

Amortization expense = Current product revenue / Total anticipated product revenue* Capitalized software costs

Straight line Method

Amortization expense = 1/Useful Life *Capitalized software costs

Accounting for Software R&D Costs Developed and Used Internally

• Costs incurred during preliminary project stage are expensed as incurred

• Development costs incurred during the application development stage are capitalized (except for training costs which are expensed as incurred)

• capitalization ends when software project is substantially complete

Accounting for Cloud Computing Arrangements

Cloud computing arrangements: Company pays a vendor to host the company’s system and data in the cloud

• Hosting arrangements: Customer recognizes an intangible asset as if it purchased the software

  • customer has contractual right to take possession of the software

  • It is feasible for customer to run or contract out the software

• service contract: either one or both of the criteria above are not met

  • expense costs in preliminary stage

  • capitalize costs in the development stage

  • expense costs in post-implementation stage