ACCT3010

Intermediate Accounting I
Professor Amy Zang

Chapters 12
10-1
 PREVIEW OF CHAPTER 12

10-2
 Intangible Asset Issues LEARNING OBJECTIVE 1
Discuss the characteristics,
valuation, and amortization of
intangible assets.
Characteristics
 Identifiable.

 Lack physical existence.

Christian Dior’s
 Not monetary assets. (FRA) most
important asset is its
Normally classified as non-current asset. brand image, not its
store fixtures.
Common types of intangibles:

1. Marketing-related. 4. Contract-related.
2. Customer-related. 5. Technology-related.
3. Artistic-related. 6. Goodwill.
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 Intangible Asset Issues

Valuation
Purchased Intangibles
 Recorded at cost.

 Includes all acquisition costs plus expenditures to make

the intangible asset ready for its intended use.

 Typical costs include:

► Purchase price.

► Legal fees.

► Other incidental expenses.

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 Valuation

Internally Created Intangibles

 Might include patents, computer software, copyrights,
and trademarks.

 Companies expense all research phase costs and some

development phase costs.

 Certain development costs are capitalized once

economic viability criteria are met.

 IFRS identifies several specific criteria that must be met

before development costs are capitalized.

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 Intangible Asset Issues

Internally Created Intangibles

ILLUSTRATION 12.1
Research and Development Stages

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 Intangible Asset Issues

Amortization of Intangibles
Limited-Life Intangibles
 Amortize by systematic charge to expense over useful life.

 Amortization expense should reflect the pattern in which

the company consumes or uses up the asset.

 Credit asset account or accumulated amortization.

 Amortization should be cost less residual value.

 Companies must evaluate the limited-life intangibles

annually for impairment.

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 Intangible Asset Issues

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 Issues

Amortization of Intangibles

ILLUSTRATION 12.2
Accounting Treatment for Intangibles

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 LEARNING OBJECTIVE 2
Types of Intangible Describe the accounting for
various types of intangible
Assets assets.

Six Major Categories:

1. Marketing-related. 4. Contract-related.

2. Customer-related. 5. Technology-related.

3. Artistic-related. 6. Goodwill.

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 Types of Intangible Assets

Marketing-Related Intangible Assets

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

 Under common law, the right to use a trademark or

trade name rests exclusively with the original user
as long as the original user continues to use it.

 Capitalize purchase price.

 No amortization.
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 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 Intangible Assets
Illustration: Green Market AG acquires the customer list of a large
newspaper for €6,000,000 on January 1, 2019. 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 for each year on the straight-line basis.

Jan. 1 Customer List 6,000,000

2019
Cash 6,000,000

Dec. 31 Amortization Expense 2,000,000

2019
Customer List * 2,000,000
2020
2021

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 Types of Intangible Assets

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 if less than the legal

life.

and Mickey
Mouse

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 Types of Intangible Assets

Contract-Related Intangible Assets

 Examples:
► Franchise and licensing agreements, construction permits,
broadcast rights, and service or supply contracts.

 Franchise (or license) with a limited life should be amortized

as operating expense over the life of the franchise.

 Franchise with an indefinite life should be carried at cost and

not amortized.

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 Types of Intangible Assets

Technology-Related Intangible Assets

 Examples:
► Patented technology and trade secrets granted by a
government body.

 Patent gives holder exclusive use for a period of 20 years.

 Capitalize costs of purchasing a patent.

 Expense all R&D costs and any development costs incurred

before achieving economic viability.

 Amortize over legal life or useful life, whichever is shorter.

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 Types of Intangible Assets
Illustration: Harcott Co. incurs $180,000 in legal costs on January 1,
2019, to successfully defend a patent. The patent’s useful life is 10
years, amortized on a straight-line basis. Harcott records the legal
fees and the amortization at the end of 2019 as follows.

Jan. 1 Patents 180,000

Cash 180,000

Dec. 31 Patent Amortization Expense 18,000

Patents (or Accumulated Amortization) 18,000

Patent Amortization Expense = ($180,000 ÷ 10) = $18,000

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 Types of Intangible LEARNING OBJECTIVE 3
Explain the accounting issues
Assets for recording 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 over the fair value of the identifiable net assets
(assets less liabilities) acquired.

Internally created goodwill should not be capitalized.

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 Goodwill Reality

• Total goodwill for all listed firms worldwide is $8trn, according

to Bloomberg. That compares to $14trn of physical assets.

• Take the top 500 European and top 500 American firms by
market value. Some 50% have a third or more of their book
equity tied up in goodwill.

• The biggest goodwill carriers are the deal-junkies: AT&T

($143bn), Anheuser-Busch InBev ($137bn), General Electric
($82bn) and Berkshire Hathaway ($81bn).

• For the top 500 European and top 500 American firms by
market value, cumulative goodwill write-offs over the past ten
years amount to $690bn.
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 Recording Goodwill

Illustration: Feng, Inc. decides that it needs a parts division to

supplement its existing tractor distributorship. The president of Feng is
interested in buying Tractorling SA. The illustration presents the
statement of financial position of Tractorling SA.

ILLUSTRATION 12.4
Tractorling Statement of Financial Position

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 Recording Goodwill

Illustration: Feng investigates Tractorling’s underlying assets to

determine their fair values. ILLUSTRATION 12.5
Fair Value of Tractorling’s Net Assets

Tractorling Company decides to accept Feng’s offer of $400,000. What

is the value of the goodwill, if any?

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 Recording Goodwill

Illustration: Determination of Goodwill.

ILLUSTRATION 12.6
Determination of Goodwill—
Master Valuation Approach

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 Recording Goodwill

Illustration: Feng records this transaction as follows.

Property, Plant, and Equipment 205,000

Patents 18,000
Inventory 122,000
Accounts Receivables 35,000
Cash 25,000
Goodwill 50,000
Liabilities 55,000
Cash 400,000

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 Recording Goodwill

Goodwill Write-Off
 Goodwill considered to have an indefinite life.

 Should not be amortized.

 Only adjust carrying value when goodwill is impaired.

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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10-25
 Recording Goodwill

Goodwill Write-Off
• On January 11, 2001, AOL acquired Time Warner for approximately $147
billion. Of this amount $127 billion was Goodwill.
o The fair value of Time Warner’s net assets must have been?

• Subsequently:
o In 1Q of 2002, AOL-TW recognized a Goodwill Impairment charge
of $54.2 billion.

o In 4Q 2002, AOL-TW recognized another Goodwill Impairment

charge of $44.7 billion.

• What exactly did AOL buy when they acquired Time Warner and how
much is it worth now (on the books)?

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 LEARNING OBJECTIVE 4
Impairment of Identify impairment procedures
and presentation requirements
Intangible Assets for intangible assets.

https://youtu.be/XEL65gywwHQ

Seinfeld and Kramer about write-off

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 LEARNING OBJECTIVE 4
Impairment of Identify impairment procedures
and presentation requirements
Intangible Assets for intangible assets.

An intangible asset is impaired when a company is not able

to recover the asset’s carrying amount either through using it
or by selling it.
The specific procedures for recording impairments depend
on the type of intangible asset—
1. limited-life or
2. indefinite-life (including goodwill).

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 Impairment of Limited-Life Intangibles

The rules that apply to impairments of property, plant, and

equipment also apply to limited-life intangibles.
The impairment loss is the carrying amount of the asset less
the recoverable amount of the impaired asset.

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 Impairment of Limited-Life Intangibles

Fair value less costs to sell means what the asset could be sold
for after deducting costs of disposal. Value-in-use is the present
value of cash flows expected from the future use and eventual
sale of the asset at the end of its useful life.
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 Impairment of Limited-Life Intangibles
Illustration: Lerch SE has a patent on how to extract oil from shale
rock, with a carrying value of €5,000,000 at the end of 2018.
Unfortunately, several recent non-shale-oil discoveries adversely
affected the demand for shale-oil technology, indicating that the patent
is impaired. Lerch determines the recoverable amount for the patent,
based on value-in-use (because there is no active market for the
patent). Lerch estimates the patent’s value-in-use at €2,000,000,
based on the discounted expected net future cash flows at its market
rate of interest.

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 Impairment of Limited-Life Intangibles

Calculate the impairment loss (based on value-in-use).

€3,000,000 Impairment Loss

€5,000,000 €2,000,000

Unknown €2,000,000

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 Impairment of Limited-Life Intangibles

Calculate the impairment loss (based on value-in-use).

€3,000,000 Impairment Loss

€5,000,000 €2,000,000

Lerch makes the following entry to record the impairment.

Loss on Impairment 3,000,000

Unknown $2,000,000
Patents 3,000,000
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 Impairment of Limited-Life Intangibles

Reversal of Impairment Loss

Illustration: The carrying value of the patent after impairment is
€2,000,000. Lerch’s amortization is €400,000 (€2000,000 ÷ 5) over
the remaining five years of the patent’s life. The amortization
expense and carrying amount after the impairment is shown below:

ILLUSTRATION 12.8
Post-Impairment Carrying Value of Patent

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 Impairment of Limited-Life Intangibles

Reversal of Impairment Loss

Early in 2020, based on improving conditions in the market for
shale-oil technology, Lerch remeasures the recoverable amount of
the patent to be €1,750,000. In this case, Lerch reverses a portion
of the recognized impairment loss.

Patents (€1,750,000 - €1,600,000) 150,000

Recovery of Impairment Loss 150,000

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 Impairment of Intangible Assets

Impairment of Indefinite-Life Intangibles Other

than Goodwill
 Should be tested for impairment at least annually.

 Impairment test is the same as that for limited-life

intangibles. That is,

► compare the recoverable amount of the intangible

asset with the asset’s carrying value.

► If the recoverable amount is less than the carrying

amount, the company recognizes an impairment.

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 Impairment of Indefinite-Life Intangibles

Illustration: Arcon Radio purchased a broadcast license for

€2,000,000. The license is renewable every 10 years. Arcon Radio
has renewed the license with the GCC 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 GCC
decided to auction these licenses to the highest bidder instead of
renewing them. Based on recent auctions of similar licenses, Arcon
Radio estimates the fair value less costs to sell (the recoverable
amount) of its license to be €1,500,000.

ILLUSTRATION 12.9
Computation of Loss on Impairment of Broadcast License

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 Impairment of Intangible Assets

Impairment of Goodwill
 Companies must test goodwill at least annually.

 Impairment test is conducted based on the cash-generating

unit to which the goodwill is assigned.

► Cash-generating unit = smallest identifiable group of assets

that generate cash flow.

 Estimation of the recoverable amount for goodwill impairments

is usually based on value-in-use estimates.

 Goodwill impairment loss reversals are not permitted.

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 Impairment of Goodwill

Illustration: Kohlbuy AG has three divisions. It purchased one

division, Pritt Products, four years ago for €2 million. Unfortunately,
Pritt experienced operating losses over the last three quarters.
Kohlbuy management is now reviewing the division (the cash-
generating unit), for purposes of its annual impairment testing.
Illustration 12.10 lists the Pritt Division’s net assets, including the
associated goodwill of €900,000 from the purchase.
ILLUSTRATION 12.10

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 Impairment of Goodwill
Kohlbuy determines the recoverable amount for the Pritt Division to
be €2,800,000, based on a value-in-use estimate.

€2,400,000 €2,800,000

No
Impairment

Unknown €2,800,000
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 Impairment of Goodwill
Assume that the recoverable amount for the Pritt Division is
€1,900,000 instead of €2,800,000.

€500,000 Impairment Loss

€2,400,000 €1,900,000

Unknown €1,900,000
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5
 Impairment of Goodwill
Assume that the recoverable amount for the Pritt Division is
€1,900,000 instead of €2,800,000.

€500,000 Impairment Loss

€2,400,000 €1,900,000

Kohlbuy makes the following entry to record the impairment.

Loss on Impairment 500,000

Goodwill Unknown 500,000

$1,900,000
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5
 LEARNING OBJECTIVE 5
Research and Describe the accounting and
presentation for research and
Development Costs development and similar costs.

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

intangible assets.

Frequently results in the development of patents or copyrights

such as new

 product,  formula,

 process,  composition, or

 idea,  literary work.

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 Research and Development Costs

Companies spend considerable sums on research and

development.

ILLUSTRATION 12.13
R&D Outlays, as a Percentage of Sales
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 Research and Development Costs

 Research costs must be expensed as incurred.

 Development costs may or may not be expensed as

incurred.

 Capitalization begins when the project is far enough along

in the process such that the economic benefits of the R&D
project will flow to the company (the project is economically
viable).

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 Research and Development Costs

Identifying R & D Activities ILLUSTRATION 12.14

Research Activities versus
Development Activities

Research Activities Examples

Original and planned investigation Laboratory research aimed at discovery of
undertaken with the prospect of gaining new knowledge; searching for applications of
new scientific or technical knowledge new research findings.
and understanding.

Development Activities Examples

Application of research findings or other Conceptual formulation and design of possible
knowledge to a plan or design for the product or process alternatives; construction
production of new or substantially of prototypes and
improved materials, devices, products, operation of pilot plants.
processes, systems, or services before
the start of commercial production or
use.

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 Research and Development Costs

Accounting for R & D Activities

Costs Associated with R&D Activities:

 Materials, equipment, and facilities.

 Personnel.

 Purchased intangibles.

 Contract Services.

 Indirect Costs.

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 Accounting for R & D Activities
Illustration 12.15 Sample R&D Expenditures and Their Accounting
Treatment.

Type of Expenditure Accounting Treatment

1. Construction of long-range research 1. Capitalize and depreciate

facility for use in current and future as R&D expense.
projects (three-story, 400,000-square-
foot building).
2. Acquisition of R&D equipment for use on 2. Expense immediately as
current project only. R&D.
3. Acquisition of machinery for use on 3. Capitalize and depreciate
current and future R&D projects. as R&D expense.

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 Accounting for R & D Activities

Type of Expenditure Accounting Treatment

4. Purchase of materials for use on 4. Inventory and allocate to

current and future R&D projects. R&D projects; expense as
consumed.
5. Salaries of research staff designing 5. Expense immediately as
new laser bone scanner. R&D.
6. Research costs incurred under contract 6. Record as a receivable.
with New Horizon, Inc., and billable
monthly.
7. Material, labor, and overhead costs of 7. Expense immediately as
prototype laser scanner (economic R&D.
viability not achieved).

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 Accounting for R & D Activities

Type of Expenditure Accounting Treatment

8. Costs of testing prototype and design 8. Expense immediately as

modifications (economic viability not R&D.
achieved).
9. Legal fees to obtain patent on new laser 9. Capitalize as patent and
scanner. amortize to overhead as
part of cost of goods
manufactured.
10. Executive salaries. 10. Expense as operating
expense.
11. Cost of marketing research to promote 11. Expense as operating
new laser scanner. expense.

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 Accounting for R & D Activities

Type of Expenditure Accounting Treatment

12. Engineering costs incurred to advance 12. Expense as operating

the laser scanner to full production stage expense. Capitalize as
(economic viability achieved). R&D.
13. Costs of successfully defending patent 13. Capitalize as patent and
on laser scanner. amortize to overhead as
part of cost of goods
manufactured.
14. Commissions to sales staff marketing 14. Expense as operating
new laser scanner. expense.

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 Research and Development Costs

Costs Similar to R & D Costs

 Start-up costs for a new operation.

 Initial operating losses.

 Advertising costs.

These costs are expensed as incurred, similar to the

accounting for R&D costs.

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 Research and Development Costs
E12.17: Compute the amount to be reported as research and
development expense.
$330,000 / 5 = $66,000
R&D
Cost of equipment acquired that will have alternative Expense
uses in future R&D projects over the next 5 years
(uses straight-line depreciation) $330,000 $66,000

Materials consumed in R&D projects 59,000 59,000

Consulting fees paid to outsiders for R&D projects 100,000 100,000

Personnel costs involved in R&D projects 128,000 128,000

Indirect costs reasonably allocable to R&D projects 50,000 50,000

Materials purchased for future R&D projects 34,000 0

$403,000

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 Presentation of R&D Costs

Companies should disclose the total R&D costs charged to

expense each period.

ILLUSTRATION 12.16
R&D Reporting

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