1 Intangible Assets Instructor Adnan Shoaib PART II: Corporate Accounting Concepts and Issues...

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1 Intangible Assets Instructor Instructor Adnan Shoaib Adnan Shoaib PART II: Corporate Accounting PART II: Corporate Accounting Concepts and Issues Concepts and Issues Lecture 14 Lecture 14

Transcript of 1 Intangible Assets Instructor Adnan Shoaib PART II: Corporate Accounting Concepts and Issues...

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Intangible Assets

InstructorInstructorAdnan ShoaibAdnan Shoaib

PART II: Corporate Accounting Concepts and PART II: Corporate Accounting Concepts and IssuesIssues

Lecture 14Lecture 14

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1. Describe the characteristics of intangible assets.

2. Identify the costs to include in the initial valuation of intangible assets.

3. Explain the procedure for amortizing intangible assets.

4. Describe the types of intangible assets.

5. Explain the conceptual issues related to goodwill.

6. Describe the accounting procedures for recording goodwill.

7. Explain the accounting issues related to intangible asset impairments.

8. Identify the conceptual issues related to research and development costs.

9. Describe the accounting for research and development and similar costs.

10. Indicate the presentation of intangible assets and related items.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

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Marketing-related

Customer-related

Artistic-related

Contract-related

Technology-related

Goodwill

Intangible Asset Issues

Types of Intangibles

Impairment of Intangibles

Research and Development

Costs

Presentation of Intangibles and Related Items

Characteristics

Valuation

Amortization

Limited-life intangibles

Indefinite-life intangibles other than goodwill

Goodwill

Summary

Identifying R&D

Accounting for R&D

Similar costs

Conceptual questions

Intangible assets

R&D costs

Intangible AssetsIntangible AssetsIntangible AssetsIntangible Assets

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Intangible Asset IssuesIntangible Asset IssuesIntangible Asset IssuesIntangible Asset Issues

LO 1 Describe the characteristics of intangible assets.

Characteristics

(1) Lack physical existence.

(2) Not financial instruments.

Normally classified as long-term asset.

Common types of intangibles:

Patents

Copyrights

Franchises or licenses

Trademarks or trade names

Goodwill

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Intangible Asset IssuesIntangible Asset IssuesIntangible Asset IssuesIntangible Asset Issues

LO 2 Identify the costs to include in the initial valuation of intangible assets.

Purchased Intangibles:

Recorded at cost.

Includes all costs necessary to make the intangible asset

ready for its intended use.

Typical costs include:

► Purchase price.

► Legal fees.

► Other incidental expenses.

Valuation

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Intangible Asset IssuesIntangible Asset IssuesIntangible Asset IssuesIntangible Asset Issues

LO 2 Identify the costs to include in the initial valuation of intangible assets.

Valuation

Internally Created Intangibles:

Generally expensed.

Only capitalize direct costs incurred in developing the

intangible, such as legal costs.

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Intangible Asset IssuesIntangible Asset IssuesIntangible Asset IssuesIntangible Asset Issues

LO 3 Explain the procedure for amortizing intangible assets.

Amortization of Intangibles

Limited-Life Intangibles:

Amortize by systematic charge 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.

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Intangible Asset IssuesIntangible Asset IssuesIntangible Asset IssuesIntangible Asset Issues

LO 3 Explain the procedure for amortizing intangible assets.

Amortization of Intangibles

Indefinite-Life Intangibles:

No foreseeable limit on time the asset is expected to

provide cash flows.

No amortization.

Must test indefinite-life intangibles for impairment at least

annually.

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Intangible Asset IssuesIntangible Asset IssuesIntangible Asset IssuesIntangible Asset Issues

LO 3 Explain the procedure for amortizing intangible assets.

Illustration 12-1Accounting Treatmentfor Intangibles

Amortization of Intangibles

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

Six Major Categories:

(1) Marketing-related.

(2) Customer-related.

(3) Artistic-related.

(4) Contract-related.

(5) Technology-related.

(6) Goodwill.

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

Marketing-Related Intangible Assets

Examples:

► Trademarks or trade names, newspaper mastheads, Internet domain names, and non-competition agreements.

In the United States trademark or trade name has legal protection for indefinite number of 10 year renewal periods.

Capitalize acquisition costs.

No amortization.

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

Customer-Related Intangible Assets

Examples:

► Customer lists, order or production backlogs, and both contractual and non-contractual customer relationships.

Capitalize acquisition costs.

Amortized to expense over useful life.

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

Illustration: Green Market Inc. acquires the customer list of a

large newspaper for $6,000,000 on January 1, 2012. 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.

Customer List 6,000,000Jan. 1

Cash 6,000,000

Amortization expense 2,000,000Dec. 31201020112012

Customer list2,000,000

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

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.

Mickey Mickey MouseMouse

andand

LO 4

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4

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.

Contract-Related Intangible Assets

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

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 a period of 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.

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

Illustration: Harcott Co. incurs $180,000 in legal costs on

January 1, 2012, to successfully defend a patent. The patent’s

useful life is 20 years, amortized on a straight-line basis. Harcott

records the legal fees and the amortization at the end of 2012 as

follows.

Patents 180,000Jan. 1

Cash 180,000

Amortization expense 9,000Dec. 31

Patents9,000

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Types of IntangiblesTypes of IntangiblesTypes of IntangiblesTypes of Intangibles

LO 5 Explain the conceptual issues related to goodwill.

Goodwill

Conceptually, 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 measured as the excess of ...

cost of the purchase overover the FMV of the identifiable net

assets purchased.

Internally created goodwill should not be capitalized.

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Illustration: 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.

Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Illustration 12-3

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Illustration: Multi-Diversified investigates Tractorling’s underlying

assets to determine their fair values.

Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Tractorling Company decides to accept Multi-Diversified’s offer of

$400,000. What is the value of the goodwill, if any?

Illustration 12-4

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Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Illustration 12-5

Illustration: Determination of Goodwill.

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Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Property, Plant, and Equipment 205,000

Patents 18,000

Inventories 122,000

Receivables 35,000

Cash 25,000

Goodwill 50,000

Liabilities 55,000

Cash 400,000

Illustration: Multi-Diversified records this transaction as follows.

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Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. The balance sheet of Local Company just prior to acquisition is:

Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Assets Cost FMVCash 15,000$ 15,000$ Receivables 10,000 10,000 Inventories 50,000 70,000 Equipment 80,000 130,000

Total 155,000$ 225,000$

Liabilities and EquitiesAccounts payable 25,000$ 25,000$ Common stock 100,000 Retained earnings 30,000

Total 155,000$ 25,000$

FMV of Net Assets = $200,000

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Book Value = $130,000

Fair Value = $200,000

Purchase Price = $300,000

Revaluation$70,000

Goodwill$100,000

Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. The value assigned to goodwill is determined as follows:

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Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Calculation of Goodwill:

Cash 15,000$

Receivables 10,000

Inventories 70,000

Equipment 130,000

Accounts payable (25,000)

FMV of identifiable net assets 200,000

Purchase price 300,000

Goodwill 100,000$

Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. The value assigned to goodwill is determined as follows:

26 LO 6 Describe the accounting procedures for recording goodwill.

Recording GoodwillRecording GoodwillRecording GoodwillRecording Goodwill

Journal entry recorded by Global:

Cash 15,000

Receivables 10,000

Inventory 70,000

Equipment 130,000

Goodwill 100,000

Accounts payable25,000

Cash300,000

Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. Prepare the journal entry to record the purchase of the net assets of Local.

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GoodwillGoodwillGoodwillGoodwill

Goodwill Write-off

Goodwill considered to have an indefinite life.

Should not be amortized.

Only adjust carrying value when goodwill is impaired.

LO 6 Describe the accounting procedures for recording goodwill.

Bargain Purchase

Purchase price less than the fair value of net assets acquired.

Amount is recorded as a gain by the purchaser.

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

Impairment of Limited-Life Intangibles

LO 7 Explain the accounting issues related to intangible-asset impairments.

Same as impairment for long-lived assets.

1. If the sum of the expected future net cash flows is less than the carrying amount of the asset, an impairment has occurred (recoverability test).

2. The impairment loss is the amount by which the carrying amount of the asset exceeds the fair value of the asset (fair value test).

The loss is reported as part of income from continuing operations, “Other expenses and losses” section.

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Presented below is information related to copyrights owned by Botticelli Company at December 31, 2012.

Cost 8,600,000$

Carrying amount 4,300,000

Expected future net cash flows 4,000,000

Fair value 3,200,000

Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

The copyright has a remaining useful life of 10 years.

(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012.

(b) Prepare the journal entry to record amortization expense for 2013 related to the copyrights.

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

Recoverability test: If the sum of the expected future net cash flows is less than the carrying amount of the asset, an impairment has occurred.

Expected future cash flow 4,000,000$

Carrying value 4,300,000

(300,000)$

Asset is ImpairedAsset is Impaired

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012.

Fair value test:

Carrying amount 4,300,000$

Fair value 3,200,000

Loss on impairment (1,100,000)$

Loss on impairment 1,100,000

Copyrights 1,100,000

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

(b) Prepare the journal entry to record amortization expense for 2013 related to the copyrights.

Carrying amount 3,200,000$

Useful life 10 years

Amortization per year 320,000$

÷÷

Amortization expense 320,000

Copyrights 320,000

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

Impairment of Indefinite-Life Intangibles Other than Goodwill

LO 7 Explain the accounting issues related to intangible-asset impairments.

Should be tested for impairment at least annually.

Impairment test is a fair value test.

► If the fair value of asset is less than the carrying

amount, an impairment loss is recognized for the

difference.

► Recoverability test is not used.

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Illustration 12-7

Illustration: Arcon Radio purchased a broadcast license for $2,000,000. Arcon Radio has renewed the license with the FCC twice, at a minimal cost. Because it expects cash flows to last indefinitely, Arcon reports the license as an indefinite-life intangible asset. Recently the FCC decided to auction these licenses to the highest bidder instead of renewing them. Arcon Radio expects cash flows for the remaining two years of its existing license. It performs an impairment test and determines that the fair value of the intangible asset is $1,500,000.

Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

Impairment of Goodwill

LO 7 Explain the accounting issues related to intangible-asset impairments.

Two Step Process:

Step 1: If fair value is less than the carrying amount of the

net assets (including goodwill), then perform a

second step to determine possible impairment.

Step 2: Determine the fair value of the goodwill (implied

value of goodwill) and compare to carrying amount.

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Presented below is net asset information related to the Mischa Division of Santana, Inc. as of December 31, 2012 (in millions):

Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

Management estimated its future net cash flows from the division to be $400 million. Management has also received an offer to purchase the division for $335 million. All identifiable assets’ and liabilities’ book and fair value amounts are the same.

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

Instructions

(a) Prepare the journal entry (if any) to record the impairment at December 31, 2012.

(in millions)

Fair value

Carrying amount, net of goodwill

Implied goodwill

Carrying value of goodwill

Loss on impairment

Step 1: The fair value of the reporting unit is below its carrying value. Therefore, an impairment has occurred.

Step 2:

Loss on impairment 25,000,000

Goodwill 25,000,000

$ 335160

175

200$ (25)

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

Instructions

(b) At December 31, 2011, it is estimated that the division’s fair value increased to $345 million. Prepare the journal entry (if any) to record this increase in fair value.

No entry necessary.

Adjusted carrying amount of the goodwill is its new accounting basis.

Subsequent reversal of recognized impairment losses is not permitted under SFAS No. 142.

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Impairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible AssetsImpairment of Intangible Assets

LO 7 Explain the accounting issues related to intangible-asset impairments.

Summary of Impairment Tests

Illustration 12-11

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Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs

LO 8 Identify the conceptual issues related to research and development costs.

Frequently results in something that a company patents or

copyrights such as:

new product,

process,

idea,

formula,

composition, or

literary work.

Research and development (R&D) costs are not in

themselves intangible assets.

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Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs

LO 8 Identify the conceptual issues related to research and development costs.

Companies spend considerable sums on research and

development.Illustration 12-12

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Identifying R & D Activities

LO 8 Identify the conceptual issues related to research and development costs.

Research ActivitiesPlanned search or critical investigation aimed at discovery of new knowledge.

Research ActivitiesPlanned search or critical investigation aimed at discovery of new knowledge.

ExamplesLaboratory research aimed at discovery of new knowledge; searching for applications of new research findings.

ExamplesLaboratory research aimed at discovery of new knowledge; searching for applications of new research findings.

Development ActivitiesTranslation 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.

Development ActivitiesTranslation 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.

ExamplesConceptual formulation and design of possible product or process alternatives; construction of prototypes andoperation of pilot plants.

ExamplesConceptual formulation and design of possible product or process alternatives; construction of prototypes andoperation of pilot plants.

Illustration 12-13

Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs

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Accounting for R & D Activities

Costs Associated with R&D Activities:

Materials, Equipment, and Facilities.

Personnel.

Purchased Intangibles.

Contract Services.

Indirect Costs.

Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs

LO 9 Describe the accounting for research and development and similar costs.

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Costs Similar to R & D Costs

Start-up costs for a new operation.

Initial operating losses.

Advertising costs.

Computer software costs.

Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs

LO 9 Describe the accounting for research and development and similar costs.

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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 allocable to R&D projects

Materials purchased for future R&D projects

$330,000

59,000

100,000

128,000

50,000

34,000

$66,000

59,000

100,000

128,000

50,000

0

R&D R&D ExpenseExpense

$403,000

$330,000 / 5 = $66,000

Research and Development CostsResearch and Development CostsResearch and Development CostsResearch and Development Costs

Compute the amount to be reported as research and development expense.

LO 9 Describe the accounting for research and development and similar costs.

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Balance Sheet

Intangible assets shown as a separate item.

Reporting is similar to the reporting of property, plant, and

equipment.

Contra accounts may not be shown for intangibles.

Companies should report as a separate item all intangible

assets other than goodwill.

Presentations of Intangibles and Related ItemsPresentations of Intangibles and Related ItemsPresentations of Intangibles and Related ItemsPresentations of Intangibles and Related Items

LO 10 Indicate the presentation of intangible assets and related items.

Presentation of Intangible Assets

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Income Statement

Report amortization expense and impairment losses in

continuing operations.

Total R&D costs charged to expense must be disclosed.

Presentations of Intangibles and Related ItemsPresentations of Intangibles and Related ItemsPresentations of Intangibles and Related ItemsPresentations of Intangibles and Related Items

LO 10 Indicate the presentation of intangible assets and related items.

Presentation of Intangible Assets

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Presentations of IntangiblesPresentations of IntangiblesPresentations of IntangiblesPresentations of Intangibles

LO 10 Indicate the presentation of intangible assets and related items.

Illustration 12-15

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Presentations of R&D CostsPresentations of R&D CostsPresentations of R&D CostsPresentations of R&D Costs

LO 10 Indicate the presentation of intangible assets and related items.

Illustration 12-16

50 LO 11 Understand the accounting treatment for computer software costs.

Diversity in Practice

Companies can either

purchase computer software or

create it.

How should companies account for the costs of developing

software?

Should they expense such costs immediately, or capitalize

and amortize them in the future?

ACCOUNTING FOR COMPUTER SOFTWARE COSTSACCOUNTING FOR COMPUTER SOFTWARE COSTS

51 LO 11 Understand the accounting treatment for computer software costs.

The Profession’s Position

FASB ASC 985-20-05 - Major recommendations of this

pronouncement are:

1. Until a company has established technological

feasibility for a software product, it should charge to

R&D expense the costs incurred in creating the product.

2. Technological feasibility is established when the

company has completed a detailed program design or a

working model.

ACCOUNTING FOR COMPUTER SOFTWARE COSTSACCOUNTING FOR COMPUTER SOFTWARE COSTS

52 LO 11 Understand the accounting treatment for computer software costs.

Accounting for Capitalized Software Costs

If companies are to capitalize software costs, then they must

establish a proper amortization pattern.

As a basis for amortization, one of two amounts is used:

1. the ratio of current revenues to current and anticipated

revenues (the percent-of-revenue approach), or

2. the straight-line method over the remaining useful life of the

asset (straight-line approach).

Must use whichever of those amounts is greater.

ACCOUNTING FOR COMPUTER SOFTWARE COSTSACCOUNTING FOR COMPUTER SOFTWARE COSTS

53 LO 11 Understand the accounting treatment for computer software costs.

Illustration: AT&T has capitalized software costs of $10 million,

and current (first-year) revenues from sales of this product of $4

million. AT&T anticipates earning $16 million in additional future

revenues from this product; it estimates that the product has an

economic life of four years. Under the two approaches, the

calculations are as follows for the first year’s amortization:

Percent-of-revenue approach Straight-line approach

ACCOUNTING FOR COMPUTER SOFTWARE COSTSACCOUNTING FOR COMPUTER SOFTWARE COSTS

54 LO 11 Understand the accounting treatment for computer software costs.

Reporting Software Costs

Companies should report the following information relating to

software.

1. Unamortized software costs.

2. The total amount charged to expense and the amounts, if

any, written down to net realizable value.

ACCOUNTING FOR COMPUTER SOFTWARE COSTSACCOUNTING FOR COMPUTER SOFTWARE COSTS

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RELEVANT FACTS

Like GAAP, under IFRS intangible assets (1) lack physical substance and (2) are not financial instruments. In addition, under IFRS an intangible asset is identifiable. To be identifiable, an intangible asset must either be separable from the company (can be sold or transferred) or it arises from a contractual or legal right from which economic benefits will flow to the company. Fair value is used as the measurement basis for intangible assets under IFRS,

As in GAAP, under IFRS the costs associated with research and development are segregated into the two components.

Costs in the research phase are always expensed under both IFRS and GAAP.

Under IFRS costs in the development phase are capitalized once technological feasibility is achieved.

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RELEVANT FACTS

IFRS permits revaluation on limited-life intangible assets. Revaluations are not permitted for goodwill and other indefinite-life intangible assets.

IFRS requires an impairment test at each reporting date for long-lived assets and intangibles and records an impairment if the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of the asset’s fair value less costs to sell and its value-in-use. Value-in-use is the future cash flows to be derived from the particular assets, discounted to present value.

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End of Lecture 14End of Lecture 14End of Lecture 14End of Lecture 14