Post on 24-Dec-2015
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Meaning of Intangible assets
Intangible assets are assets which have no physical existence.
They are long-lived non-material rights which may generate future revenues
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Example of intangible assets
Goodwill Research and development expenditures Patents Copyrights Franchises Trademarks
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Problems in accounting for intangible assets Some intangible assets are self-developed. Their
costs cannot be measured objectively and easily Some intangible assets such as goodwill do not
have definite lives and they are not capable of being amortized over their indefine lives
It is difficult to identify specific revenues arising from the use of intangibles
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An intangible asset should be recognized if it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; the cost of the asset can be measured reliably
An intangible asset should be measured its initially at cost
The cost of an intangible asset comprises its purchase price including all other expenditures on preparing the asset for its intended use such as import duties and professional fees for legal services. Any trade discount and rebates are deducted in arriving at the cost
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To write off the expenditure incurred from which no intangible asset can be created
Dr. Profit and loss
Cr. Bank
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With creating intangible assets, the following expenditures should be recognized as expenses when it is incurred: Expenditure on start-up activities which
comprises establishing cost, pre-opening cost for new facility, new operation or business
Expenditure on training activities, advertising and promotional activities and relocating or re-organizing part of all of an enterprises
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Expenditure on an intangible item that was initially recognized as an expense in previous annual financial statement or interim financial reports should not be recognized as part of the cost of an intangible asset at a later date
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Subsequent expenditure can be capitalized if the expenditure will enable the asset to generate future economic benefits in excess of its original level; and the expenditure can be measured and attributed to the asset reliably
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After initial recognition, an intangible asset should be carried at its cost less any accumulated amortization and and any accumulated impairment losses
The intangible asset should be amortized on a systematic basis over its useful lives (not exceed 20 years or the period of legal right)
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To record the provision for impairment loss
Dr. Profit and loss
Dr. Accumulated amortization
Cr. Intangible assets
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When the carrying amount (cost less accumulated amortization) exceeds the recoverable amount of an intangible asset, there is an impairment loss
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After revaluationTo record revaluation surplus
Dr. Intangible asset
Dr. Accumulated amortization
Cr. Revaluation reserve
To record the reversal of previous impairment loss that was recognized as an expenses
Dr. Intangible asset
Dr. Accumulated amortization
Cr. Profit and loss
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After initial recognition, an intangible asset should be carried at a revalued amount
After revaluation, the intangible asset should be stated at its fair value less any subsequent amortization and any subsequent accumulated impairment losses
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Definition
Goodwill is the difference between the value of a business as a whole and the aggregate of the fair value of its separable net assets
Goodwill = Selling price as a going concern – Fair value of separable net assets = Selling price – ( Assets – Liabilities)
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Nature of Goodwill
A business may be valued higher as a going concern, or a buyer may be willing to pay more for a business as a going concern than the total value of net assets because of the favourable attributes a firm owns.
Some of advantages which may add to the value of a business as a going concern Good location Good customer relations Good reputation Well-known products Experienced and efficient employees and management team Good relation with suppliers
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Characteristics
Is intrinsic to the business Is self-developed The value of goodwill may fluctuate widely
according to internal and external circumstances
The value of goodwill is subjective according to different valuers.
Why intrinsic?
Its existence depends on the continuance of the business. It cannot be realized separately from the business as a whole.
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Calculation of goodwill
Subjective Judgement Average Sales/Fees/Profits Method Super Profit Method
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Subject Judgement Estimate the value of goodwill with reference
to some intangible factors and according to their professional judgement
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Average Sales/Fees/Profit Method It can be calculated on gross average or weight
average
Goodwill = Average annual sales/fees/profits over a stated number of years * a factorThe factor is usually stated as a certain number of years’ purchase of the average sales/fees/profits
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Year Annual Sales$
1995 100000 1996 200000 1997 300000
(a) Goodwill is valued at 3 years’ purchase of the average annual sales of the past3 years:
Average annual sales = ($100000+200000+300000 ) /3 = $200000
Goodwill = $200000 X3 = $600000
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(b) Goodwill is valued at the 3 years’ purchase of the weighted average of the annual sales of the past 3 years
Weighted average annual sales = (100000 x 1 + 200000 x 2 + 300000 x 3)
1+2+3 = 1400000 6 = 233333 (Calculation to the nearest dollar)
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Super Profit Method A business with goodwill is expected to be
able to earn more profit than a business without goodwill
The extra profit earned is called the super profit
Statement Calculating Super Profit
Average annual net profit X
Less: Reasonable remuneration to the owner X
Reasonable return on the capital employed in the
tangible assets X X
Super profit X
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Chan is leaving the partnership, and goodwill is to be revalued at 3 years’ purchase of the super profit. The expected rate of return on net tangible assets is 10 %, after paying a management fee of $500. The calculation of the super profit is to be based on the average profits of the last four years.
Net profit from 1994-1997 is $5000, $6500, $6500, $7000
Expected return on net tangible assets = Net tangible assets * 10%. Expected return is $5000.
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AnswerStatement Calculating Super Profit
$ $Average net profit(5000+6500+6500+7000)/4 6250Less: Management fee 500
Expected rate of returnon net tangible assets 5000 5500
Super profit 750
Goodwill= $750 X 3 = $2250
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Definition
It is the goodwill developed by the business internally.
Over a long period in a certain trade, the business has developed many good relations
Therefore, the public estimates that the value of the business as a going concern is higher than the value of its net assets
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Reasons supporting this argument It is an internally generated goodwill which cannot
be attributed to separately intangible expenditures It is intrinsic to the business. It cannot be sold as a
separate asset The value of non-purchased goodwill may
fluctuate widely according to internal and external circumstances
The valuation and verifiability of the existence of non-purchased goodwill are subjective
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Definition
It arises when a business acquires another as a going concern
It is the difference between the purchase consideration of the company acquired as a going concern and the fair value of its net assets
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Accounting treatments
Purchased goodwill is recorded at cost less any accumulated amortization and any accumulated impairment losses
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Purchased goodwill should be measured initially at cost
Reasons Money has been spent to acquire the goodwill,
so it is difficult to argue that purchased goodwill is not an asset
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After initial recognition, purchased goodwill should be carried at its cost less any accumulated amortization
Purchased goodwill should be amortized on a systematic basis over its useful life (not exceed 20 years)
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When the carrying amount (cost less accumulated amortization) exceeds the recoverable amount of an intangible asset, there is an impairment loss
The impairment loss should be allocated firstly to the goodwill, and then the other assets proportional to the carrying amount of each asset
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Negative goodwill
Negative goodwill arises in a business acquisition when the fair market value of the net assets of the acquired company exceeds the purchase price paid
It is an unrealized capital profit which should be credited to the reserves
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Negative goodwill arises when
There is a bargain purchase due to a quick sale
The purchase price has been reduced for the expected future cost or losses
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3 steps for accounting negative goodwill Ascertain the amount of the negative goodwill Identify future losses and expenses Remaining negative goodwill
The amount of negative goodwill not exceeding the fair value of acquired identifiable non-monetary assets should be recognized as income on a systematic basis over the remaining weighted average useful life of the identifiable acquired depreciable/amortizable asset
The amount of negative goodwill in excess of the fair value of acquired identifiable non-monetary assets should be recognized as income immediately
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On 1 January 2001, Big Ltd. acquired Small Ltd. for a purchase consideration of $200000. The fair value of the net assets of Small Ltd. at the date of acquisition was $440000 including:
Tangible assets $100000Intangible assets $20000Cash $320000
$440000
The negative goodwill = $440000-$200000 = $240000It is expected that Small Ltd. will incur a loss of $30000Over the next two years
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3 steps for accounting negative goodwill are shown as follows:(a) Ascertain the amount of the negative goodwill
1 Jan 2001 Dr. Business purchase $240000Cr. Negative goodwill $240000
(b) Identify the negative goodwill of $30000 relating to future losses and expenses over the next two years31 Dec 2001Dr. Negative goodwill $15000
Cr. Profit and loss $1500031 Dec 2002Dr. Negative goodwill $15000
Cr. Profit and loss $15000( c) Remaining negative goodwill• the first of $120000 will be released over the weighted
average useful lives of tangible and intangible asset• $90000 will be credited to P/L immediately
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Accounting for goodwill in partnership
Only purchased goodwill is to be brought into the accounts. In sole trader’s accounts, goodwill is to be recognized and recorded in the books only if the business is acquired as a going concern
In partnerships, however, goodwill is brought into the books whenever there is a change in the partnership such as: Admission of a new partner Retirement of an old partner Change of the profit-sharing ratio
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Each partner has a share of the profit-sharing ratio. At a change in the partnership, goodwill must be taken into account and shared among the existing partners, according to the existing profit-sharing ratio
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Goodwill on the admission of a new partner
The new partner is required to pay for his share of the tangible assets as well as the goodwill, according to the profit-sharing ratio
On the admission of a new partner, goodwill must be revalued
However, not all business keep a goodwill account in their books. Goodwill adjustments can be done: Goodwill account opened Goodwill account not opened
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Goodwill account opened
The value of the goodwill will be credited to the old partners’ capital accounts, which represents an increase in the resources they own, while the new partner will not have a share of the goodwill
Dr Goodwill account
Cr Capital account ( old partners only
With the value of goodwill
With their share of goodwill in old ratio
Dr Goodwill account
Cr Capital account ( old partner
With the increase in the value of goodwill, share in the old ratio
Dr Capital account (old partner)
Cr Goodwill account
With the decrease in the value of goodwill, share in the old artio
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Goodwill account not opened
Goodwill is intangible in nature. It cannot be disposed of separately. Therefore, some businesses prefer not to maintain a goodwill account
The new partner may be required to pay extra cash, or have his capital balance reduced, for his share of goodwill
Dr Goodwill account
Cr Capital account (old partners only)
Share goodwill among old partners in old profit-sharing ratio
Dr Capital account ( all partners)
Cr Goodwill account
Written off goodwill among all partners in the new profit-sharing ratio
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Chan and Wong were partners sharing profits and losses equally.
On 1 January 1998, they admitted Lee as a new partner who was required to introduce $600 as capital. The profits are now to be shared among Chan, Wong and Lee equally.
Goodwill is valued at $300. The balance sheet before the admission of the new partner is shown as follows:
Chan and WongBalance Sheet as at 31 December 1997
Assets 1,200 Capital Chan 600 Wong 600
1,200 1,200
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Goodwill account openedGoodwill
Capital: Chan (1/2) 150 Wong (1/2) 150
300 300
Capital
Chan Wong Lee Chan Wong Lee
Balance c/f 750 750 600 Goodwill 150 150
Cash 600
750 750 600 750 750 600
Balance c/f 300
Balance b/f 600 600
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Goodwill account openedBalance Sheet as at 31 December 1998
AssetsGoodwill 300
CapitalChan 750
Other Assets (1,200 + 600) 1,800 Wong 750Lee 600
2,100 2,100New capital balance
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Goodwill account not opened CapitalChan Wong Lee Chan Wong Lee
Goodwill : new ratio 100 100 100
Goodwill: old ratio 150 150Cash 600
750 750 600 750 750 600
Balance c/f 650 650 500
Balance b/f 600 600
Before admission After admission
Partner Old ratio Share of goodwill
New ratio Share of goodwill
Gain/loss
Chan 1/2 $150 1/3 $100 $50 loss
Wong 1/2 $150 1/3 $100 $50 loss
Lee 1/3 $100 $100 gain
$300 $300
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Goodwill account not openedBalance Sheet as at 31 December 1998
Assets CapitalChan 650Wong 650Lee 500
1,800 1,800
Assets (1,200 + 600) 1,800
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Definition
Pure research An investigation undertaken in order to gain new
scientific knowledge but not directed towards any specific aim or application
Applied research An investigation undertaken in order to gain new
scientific knowledge but directed towards any specific aim or application
Development research The use of existing scientific or technical knowledge in
order to produce new or improved products for the sake of commercial production or application
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Accounting treatment – research cost Pure and applied research
Research costs should be written off as incurred The prudence concept requires the costs to be
written off unless it is reasonably certain that sales will be made in the future which will fully cover those costs
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Accounting treatment – development cost Development expenditures
Development expenditures should be written off as incurred
Development expenditures can be deferred to future periods and recorded as an asset
OR
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Development expenditures can be deferred to future periods and recorded as an asset,when the following conditions are satisfied: The project is clearly defined The expenditures are identified separately There is reasonable certainty about the outcome of the
project The deferred development expenditures are expected to
be recover from related future sales or other revenues The business has adequate resources to complete the
project
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Deferred development expenditures should be amortized on a systematic basis over the period in which the product is sold. The amortization starts in the year that commercial production starts
When there is any doubt about the certainty of the future revenue, the unamortized amount of deferred expenditures must be written off immediately
Reinstatement of previously written-down deferred expenditure should be credited to P/L
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Reversal of impairment loss is rstricted to the amount that would restore the carrying amount as if no impairment loss has been recognized
Any fixed assets acquired for development activities should be capitalized and depreciated over their useful lives
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Definition
A trademark is the legal protection afforded the names, symbols, and other specific identities assigned to a product
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Valuation of trademark
The costs capitalized include design, registration and the legal cost of successfully defending the trademark in court
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Accounting for trademark
A trademark is deferred and amortized as an expense over the shorter if the legal life or economic life
It is generally considered to have no limited term of existence or natural limited life. However, the legal protection of a trademark is subject to renewal after a number of years
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Definition
A patent is an exclusive right to use, manufacture, process, or sell a product granted by the government
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The valuation of patent
Patent can be purchased from the inventor or holder, or they can be generated internally
When a patent is purchased from the inventor, the cost capitalized include the acquisition cost, legal cost and the legal costs of successfully defending a patent in court
It a patent results from successful research and development efforts, the costs capitalized include only the legal costs such as registration fees and attorney fees, incurred in obtaining the patent
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Accounting treatment
The research and development costs spent to develop the patent must be written off to expenses as they are incurred
A patent should be amortized over its remaining legal life or economic life, whichever is shorter
It the patent is lost in court, it should be written off and shown as an exceptional loss
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Definition
A copyright is the exclusive rights of the creator or heirs to reproduce or sell an artistic or published work
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Accounting treatment
A copyright should be amortized over the shorter of its economic or legal life
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Accounting for franchise
A franchise is an exclusive rights granted to a franchise permitting him to operate using the franchiser’s name