Intructor manual intermediate accounting 15th kiesoch12

When intangibles are acquired in exchange for stock or otherassets, the cost of the intangible is the fair value of the consideration given or the fairvalue of the intangible received, w

CHAPTER 12 Intangible Assets

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Brief

Concepts for Analysis

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives

Brief

1 Describe the characteristics of intangible assets 1, 2, 3

2 Identify the costs to include in the initial valuation

5 Explain the conceptual issues related to goodwill 12, 13

56 ExplainDescribe the accounting issuesprocedures

for recording goodwill.

67 Explain the accounting issues related to

intangible-asset impairments.

78 Identify the conceptual issues related to research

and development costs.

5, 9

89 Describe the accounting for research and

development and similar costs.

9, 10, 11 , 12 4, 6, 8,

16, 17

4

910 Indicate the presentation of intangible assets

and related items.

ASSIGNMENT CHARACTERISTICS TABLE

Time (minut es)

E12-9 Accounting for patents, franchises, and R&D Moderate 15–20

*E12-18 Accounting for computer software costs Moderate 10–15

*E12-19 Accounting for computer software costs Moderate 15–20

P12-3 Accounting for franchise, patents, and trade name Moderate 20–30

CA12-1 Accounting for pollution expenditure Moderate 25–30 CA12-

12

CA12-23

CA12- Accounting for research and development costs Moderate 25–30

CA12-45

Accounting for research and development costs Moderate 20–25

LEARNING OBJECTIVES

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 accountingconceptual issues for recordingrelated to goodwill

6 6 Describe the accounting procedures for recording goodwill

7 Explain the accounting issues related to intangible-asset impairments

78 Identify the conceptual issues related to research and development costs

89 Describe the accounting for research and development and similar costs

910 Indicate the presentation of intangible assets and related items

*11 Understand the accounting treatment for computer software costs

*This material is covered in an Appendix to the chapter

CHAPTER REVIEW

*Note: All asterisked (*) items relate to material contained in the Appendix to the chapter.

1 Chapter 12 discusses the basic conceptual and reporting issues related to intangible assets

Characteristics of Intangibles

Valuing and Amortizing Intangibles

2 (L.O 1) The characteristics of intangible assets are: (1) they lack physical existence,   and(2) they are not a financial instrument The most common types of intangibles reported arepatents, copyrights, franchises, licenses, trademarks, trade names, and goodwill

Valuation of Intangibles

3 (L.O 2) Cost is the appropriate basis for recording purchased intangible assets Like

tangible assets, cost includes acquisition price and all other expenditures necessary inmaking the asset ready for its intended use—for example, purchase price, legal fees, andother incidental expenses When intangibles are acquired in exchange for stock or otherassets, the cost of the intangible is the fair value of the consideration given or the fairvalue of the intangible received, whichever is more clearly evident Costs incurred to

create internally-created intangibles are generally expensed as incurred.

Amortization of Intangibles

4 (L.O 3) Intangibles have either a limited (finite) useful life or an indefinite useful life An 

intangible asset with a limited life is amortized over its expected useful life.; A anintangible asset with an indefinite life is not amortized

Limited-Life Intangibles

5 The expiration of intangible assets is called amortization Limited-life intangibles should

be amortized by systematic charges to expense over their respective useful lifelives Theuseful life should reflect the periods over which these assets will contribute to cash flows

6 The amount of amortization expense for a limited-life intangible asset should reflect thepattern in which the asset is consumed or used up, if that pattern can be readilydetermined If not, the straight-line method of amortization should be used When intangibleassets are amortized, the charges should be shown as expenses, and the credits should

be made either to the appropriate asset accounts or to separate accumulated amortizationaccounts The amount of an intangible asset to be amortized should be its cost lessresidual value

Indefinite-Life Intangibles

7 If no legal, regulatory, contractual, competitive, or other factors limit the useful life of an

intangible asset, the useful life is considered indefinite An intangible with an indefinite

life is not amortized, instead it is tested for impairment

Marketing-Related Intangible Assets

8 (L.O 4) Marketing-related intangible assets are those assets primarily used in the

marketing or promotion of products or services Examples are trademarks or trade names,newspaper masthead, Internet domain names, and noncompetition agreements

9 A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies

a particular company or product The right to use a trademark or trade name, whether it isregistered or not, rests exclusively with the original user as long as the original usercontinues to use it Registration with the U.S Patent and Trademark Office provides legalprotection for an indefinite number of renewals for a period of 10 years each When thetotal cost of a trademark or trade name is insignificant, it can be expensed rather thancapitalized In most cases, the life of a trademark or trade name is indefinite, and thereforeits cost is not amortized

Customer-Related Intangible Assets

10 Customer-related intangible assets occur as a result of interactions with outside parties.

Examples are customer lists, order or production backlogs, and both contractual andnoncontractual customer relationships

Artistic-Related Intangible Assets

11 Artistic-related intangible assets involve ownership rights to plays, literary works,

musical works, pictures, photographs, and video and audiovisual material These ownership

rights are protected by copyrights A copyright is a federally granted right that all authors,

painters, musicians, sculptors, and other artists have in their creations and expressions

A copyright is granted for the life of the creator plus 70 years, and is not renewable Itgives the owner, or heirs, the exclusive right to reproduce and sell an artistic or publishedwork Copyrights are not renewable Generally, the useful life of the copyright is less thanits legal life (life of the creator plus 70 years) Costs of defending a copyright arecapitalized The costs of the copyright should be allocated to the years in which thebenefits are expected to be received

Contract-Related Intangible Assets

12 Contract-related intangible assets represent the value of rights that arise from contractual

arrangements Examples are franchise and licensing agreements, construction permits,broadcast rights, and service or supply contracts They can have limited or indefinite lives.The cost of a contract-related intangible with a limited life should be amortized asoperating expense over the life of the franchise; whereas those with an indefinite lifeshould be carried at cost and not amortized

13 A One contract-related intangible asset is a franchise, is an contractual arrangementunder 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, usuallywithin a designated geographical area

14 A license or permit is a contract the arrangement commonly entered into by agovernmental body and a business enterprise that uses public property Franchises andlicenses can have limited or indefinite lives The cost of a franchise (or license) with alimited life should be amortized as operating expense over the life of the franchise;whereas those with an indefinite life should be carried at cost and not amortized

Technology-Related Intangible Assets

1315 Technology-related intangible assets relate to innovations or technological advances

Examples are patented technology and trade secrets A patent gives the holder exclusive

right to use, manufacture, and sell a product or a process for a period of 20 years withoutinterference or infringement by others If a patent is purchased from an inventor (or otherowner), the purchase price represents its cost Research and development costs related

to the development of the product, process, or idea that is subsequently patented must beexpensed as incurred All unrecovered legal fees and other costs incurred in successfullydefending & patent are charged to the patent account The costs of the patent should beamortized over its legal life or its useful life, whichever is shorter

Goodwill

1416 (L.O 5 and 6) Goodwill is the excess of cost over fair value of the identifiable net assetsacquired when purchasing a business In a business combination, the cost (purchaseprice) is assigned, where possible, to the identifiable tangible and intangible net assets, and

the remainder is recorded in an intangible asset account called goodwill Goodwill

generated internally should not be capitalized in the accountsit is recorded only when

an entire business is purchased To record goodwill, the fair value of the net tangible andidentifiable intangible assets are compared with the purchase price of the acquiredbusiness Goodwill is considered to have an indefinite life and therefore should not beamortized

17 A bargain purchase results when the fair value of the net assets acquired is higher than

the purchase price of the assets The FASB requires that the excess be recognized as again and that the nature of the gain be disclosed

Impairments of Limited - Life Intangibles

1518 (L.O 67)  The rules that apply to impairments of property, plant, and equipment also

apply to limited-life intangibles When the carrying amount of a long-lived asset

(property, plant, and equipment or intangible assets) is not recoverable, a write-off of theimpairment is needed To determine if property, plant, or equipmentthe asset is has been

impaired, a recoverability test is used The first step of the test requires, an estimate of thefuture net cash flows expected from the use of that asset and its eventual disposition are

to be determined If the sum of the expected future net cash flows (undiscounted) is less

uses the fair value test to measure the impairment loss If an impairment loss has been

incurred, it is the amount by whichby comparing the carrying amount of the asset exceedswith its fair value The impairment loss is reported as part of income from continuingoperations, generally in the “Other expenses and losses” section

Impairments of Indefinite-Life Intangibles

1619.The rules that apply to impairments of property, plant, and equipment also apply tolimited-life intangibles Indefinite-life intangibles other than goodwill should be tested for

impairment at least annually using the fair value test This test compares the fair value of

the intangible asset with the asset’s carrying amount If the fair value of the intangibleasset is less than the carrying amount, impairment is recognized

Impairment of Goodwill

1720 The impairment rule for goodwill is a two-step process First, the fair value of thereporting unit should be compared to its carrying amount including goodwill If the fairvalue of the reporting unit is greater than the carrying amount, goodwill is considered not

to be impaired, and the company does not have to do anythingmakes no adjustment.However, if the fair value is less than the carrying amount of the net assets, then thesecond step compares the fair value of the goodwill to its carrying amount and theimpairment is the difference between the carrying amount and the fair value

1821 Once an impairment loss is recorded, the reduced carrying amount of an asset held foruse becomes its new cost basisand is not changed except for depreciation oramortization in future periods or for additional impairments Even if the fair value of animpaired asset increases, a company may not recognize restoration of the previouslyrecognized impairment loss.

19 Even if the fair value of an impaired asset increases, a company may not recognizerestoration of the previously recognized impairment loss

Research and Development Costs

2022 (L.O 78) Research activities consist of Planned planned research or criticalinvestigation aimed at discovery of new knowledge are research activities Development activities consist of tTranslation of research findings or other knowledgeinto a plan or design for a new product or process or for a significant improvement to anexisting product or process whether intended for sale or use are development activities In general, all research and development costs are to be charged to expensewhen incurred

2123 (L.O 89)  The costs associated with R&D activities and the accounting treatmentaccorded them are as follows:

a Materials, Equipment, and Facilities  Expense the entire costs, unless the items havealternative future uses (in other R&D projects or otherwise), in which case carry asinventory and allocate as consumed; or capitalize and depreciate as used

b Personnel  Salaries, wages, and other related costs of personnel engaged in R&Dshould be expensed as incurred

c Purchased Intangibles  Recognize and measure at fair value After initial tion, account for in accordance with their nature (either limited-life or indefinite-lifeintangibles)

recogni-d Contract Services  The costs of services performed by others in connection with thereporting company’s R&D should be expensed as incurred

e Indirect Costs  A reasonable allocation of indirect costs shall be included in R&Dcosts, except for general and administrative cost, which must be clearly related inorder to be included and expensed

2224 Start-up costs, initial operating costs, and advertising costs are also expensed as

incurred Computer software costs are discussed on the book’s companion website

Presentation of Intangibles and Related Items

2325 (L.O 910) On the balance sheet, all intangible assets other than goodwill should be grouped together and reported as a separate line item If goodwill is present, it also should

be reported as another separate line item

26 On the income statement, amortization expense and impairment losses for intangible assetsother than goodwill should be presented as part of continuing operations Goodwillimpairment losses should also be presented as a separate line item in the continuingoperations section, unless the goodwill impairment is associated with a discontinuedoperation.

2427 Companies should disclose, generally in the notes, the total R&D cost charged toexpense during each period for which they present an income statement

Accounting for Computer Software Costs

*25 (L.O 11) Costs incurred in creating a computer software product that is to be sold, leased  ,

or otherwise marketed to third parties should be charged to research and developmentexpense when incurred until technological feasibility has been established for the product.Technological feasibility is established upon completion of a detailed program design orworking model

*26 If software is purchased and it has alternative future uses, then it may be capitalized

*27 When software costs are capitalized companies are required to use the greater of (1) theratio of current revenues to current and anticipated revenues (percent-of-revenueapproach), or (2) the straight-line method over the remaining useful life of the asset(straight-line approach) as a basis for amortization

*28 Capitalized software costs should be valued at the lower of unamortized cost or netrealizable value If net realizable value is lower, then the capitalized software costs should

be written down to this value Once written down, they may not be written back up

LECTURE OUTLINE

This chapter can be covered in two or three class sessions Students generally do not havedifficulty in understanding the accounting procedures related to the capitalization of intangiblesand their subsequent amortization However, the accounting for impairments does may causesome confusion

A Intangible Asset Issues

TEACHING TIP TEACHING TIP Illustration 12-1 can be used to provide an overview of valuation and amortization topics.

1 (L.O 1) Characteristics of intangible assets. 

a They lack physical existence

b They are not financial instruments

2 (L.O 2) Valuation of intangible assets. 

a Purchased intangibles are recorded at cost

(1) Includes purchase price, legal fees, and other incidental expenses

(2) If acquired for by exchanging stock or other assets, the cost is the fair value ofthe consideration given or the fair value of the intangible received, whichever

is more clearly evident

b Internally created intangibles

(1) Only direct costs incurred in developing the intangible are capitalized, e.g.,legal costs In general, costs of internally created intangibles are recognized

as expenses when incurred

3 (L.O 3) Amortization of Intangibles. 

TEACHING TIP Illustration 12-1 can be used to provide an overview of the accounting treatment of

intangible assets

a Limited-life intangibles are amortized over their useful lives Factors affecting

useful life are:

(1) Expected use of the asset

(2) Expected useful life of a related asset

(3) Any legal, regulatory, or contractual provisions that may limit the useful life.(4) Provisions that enable renewal or extension of the asset’s legal or contractuallife without substantial cost

(5) The effects of obsolescence, demand, competition, and other economic factors.

cash flows from the asset

b Amortizable base is equal to cost less residual value

(1) Residual value is assumed to be zero, unless the intangible has value toanother company at the end of its useful life

(2) The intangible has value to another company at the end of its useful life

c Indefinite-life intangibles are not amortized, but are tested for impairment annually.

B (L.O 4) Types of Intangible Assets. 

a Trademarks and trade names.

(1) Considered to be indefinite-life intangibles, and therefore, not amortized

(2) If insignificant cost, it is usually expensed

b Company names.

c Domain names

2 Customer-related intangible assets R—result from interactions with outside parties

a Customer lists, order or production backlogs, and contractual or noncontractualcustomer relationships

b Amortized over the asset’s useful life

c Residual value is assumed to be zero, unless the asset’s useful life is less than theeconomic life and reliable evidence exists about the residual value

3 Artistic-related intangible assets O—ownership rights to plays, literary works,musical works, pictures, photographs, and video and audiovisual material.

a Copyrights are granted for the life of the creator plus 70 years.

b Useful life is usually less than legal life

c Costs of defending a copyright are capitalized

4 Contract-related intangible assets —rights Rights that arise from contractualarrangements.

a Franchise — Ccontractual arrangement under which the franchisor grants thefranchisee certain rights

(3) Limited-life franchises should be amortized over the term of the contract

(4) Indefinite-life franchises should be carried at cost and not amortized

(5) Annual payments under franchise agreements are recognized as operating

expenses in the period incurred

5 Technology-related intangible assets R—relate to innovations or technologicaladvances

a Patents E—exclusive rights to use, manufacture, and sell a product or process for

20 years

b Amortized over the useful life or legal life, whichever is shorter

c Legal fees and other costs incurred in successfully defending a patent suit arecapitalizable

6 (L.O 5) Goodwill Represents— the future economic benefits arising from the otherassets acquired in a business combination that are not individually identified andseparately recognized

concern” valuation and cannot be separated from the business as

a whole

b

ab Internally generated goodwill is not recordedcapitalized

bc Purchased goodwill is recorded as the excess of the purchase price (cost) of anacquired business over the fair value of the identifiable net assets acquired, oftenreferred to an a residual amount

c.d Goodwill is the residual amount—the excess of cost over the fair value ofidentifiable net assets acquiredIdentifiable assets and liabilities are revalued andrecorded at fair value

T EACHING T IP Illustration 12-3 provides a numerical example showing how goodwill is recognized

calculated and accounted for and recorded as the excess of cost over the fair value ofidentifiable net assets