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Intangible CHAPTER Assets
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions Brief Exercises Exercises Problem s 1, 2, 3, 4 Concepts for Analysis 1, 2, 3
1.
Intangible assets; concepts, definitions; items comprising intangible assets. Patents; franchise; organization costs; trade name. Goodwill. Impairment of intangibles. Research and development costs and similar costs. Computer software costs.
1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 26, 27, 29 9, 10, 13, 14, 25, 27, 29 12, 13, 14, 18 15, 16, 17, 18, 26, 29 19, 20, 21, 22, 23, 24 30, 31, 32 1, 2, 3, 4, 7, 12, 13 5, 6, 8 7, 8 9, 10, 11, 12
1, 2, 3, 5, 6
1, 2 2. 4, 5, 6, 7, 8, 9, 10, 11, 13 6, 12, 13, 15 14, 15 4, 16, 17 1, 2, 3, 4, 6 5, 6 6 4, 5 5. 1, 2, 3
3. 4.
*6.
14
18, 19
*This material is covered in an Appendix to the chapter.
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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. *11. Describe the characteristics of intangible assets. Identify the costs to include in the initial valuation of intangible assets. Explain the procedure for amortizing intangible assets. Describe the types of intangible assets. Explain the conceptual issues related to goodwill. Describe the accounting procedures for recording goodwill. Explain the accounting issues related to intangibleasset impairments. Identify the conceptual issues related to research and development costs. Describe the accounting for research and development and similar costs. Indicate the presentation of intangible assets and related items. Understand the accounting treatment for computer software costs. 9, 10, 11, 12 13 14 18, 19 5 6, 7, 8, 9 1, 2, 3, 4, 5 1, 2, 3, 4, 12, 13 Brief Exercises Exercises 1, 2, 3 1, 2, 3, 6 5, 7, 9, 10, 11 1, 2, 3, 6 4, 5, 6, 7, 9, 10, 11, 13 1, 2, 3 12, 13 5, 6 12, 13, 15 5, 6 14, 15 5, 9 4 6, 8, 16, 17 4, 6 Problems
*This material is covered in an Appendix to the chapter.
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ASSIGNMENT CHARACTERISTICS TABLE
Item E12-1 E12-2 E12-3 E12-4 E12-5 E12-6 E12-7 E12-8 E12-9 E12-10 E12-11 E12-12 E12-13 E12-14 E12-15 E12-16 E12-17 *E12-18 *E12-19 P12-1 P12-2 P12-3 P12-4 P12-5 P12-6 CA121 CA122 CA123 CA124 CA125 Description Classification issuesintangibles. Classification issuesintangibles. Classification issuesintangible asset. Intangible amortization. Correct intangible asset account. Recording and amortization of intangibles. Accounting for trade name. Accounting for organization costs. Accounting for patents, franchises, and R&D. Accounting for patents. Accounting for patents. Accounting for goodwill. Accounting for goodwill. Copyright impairment. Goodwill impairment. Accounting for R&D costs. Accounting for R&D costs. Accounting for computer software costs. Accounting for computer software costs. Correct intangible asset account. Accounting for patents. Accounting for franchise, patents, and trade name. Accounting for R&D costs. Goodwill, impairment. Comprehensive intangible assets. Accounting for pollution expenditure. Accounting for pre-opening costs. Accounting for patents. Accounting for research and development costs. Accounting for research and development costs. Level of Difficulty Moderate Simple Moderate Moderate Moderate Simple Simple Simple Moderate Moderate Moderate Moderate Simple Simple Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate Time (minutes) 1520 1015 1015 1520 1520 1520 1015 1015 1520 2025 1520 2025 1015 1520 1520 1520 1015 1015 1520 1520 2030 2030 1520 2530 3035 2530 2025 2530 2530 2025
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SOLUTIONS TO CODIFICATION EXERCISES
CE12-1
According to the Master Glossary: (a) Intangible assets are assets (not including financial assets) that lack physical substance. (The term intangible assets is used to refer to intangible assets other than goodwill.) (b) Goodwill is the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The amount recognized as goodwill includes acquired intangible assets that do not meet the criteria in Topic 805 for recognition as an asset apart from goodwill. (c) Research and Development: Research is planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service (referred to as product) or a new process or technique (referred to as process) or in bringing about a significant improvement to an existing product or process. Development is the translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use. It includes the conceptual formulation, design, and testing of product alternatives, construction of prototypes, and operation of pilot plants. (d) A development stage entity is an entity devoting substantially all of its efforts to establishing a new business and for which either of the following conditions exists: 1. Planned principal operations have not commenced. 2. Planned principal operations have commenced, but there has been no significant revenue therefrom.
CE12-2
See FASB ASC 350-30-35. In the discussions related to Determining the Useful Life of an Intangible Asset 35-1 The accounting for a recognized intangible asset is based on its useful life to the reporting entity. An intangible asset with a finite useful life shall be amortized; an intangible asset with an indefinite useful life shall not be amortized. The useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity. The useful life is not the period of time that it would take that entity to internally develop an intangible asset that would provide similar benefits.
35-2
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CE12-2 (Continued)
35-3 The estimate of the useful life of an intangible asset to an entity shall be based on an analysis of all pertinent factors, in particular: The expected use of the asset by the entity. The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate. Any legal, regulatory, or contractual provisions that may limit the useful life. The cash flows and useful lives of intangible assets that are based on legal rights are constrained by the duration of those legal rights. Thus, the useful lives of such intangible assets cannot extend beyond the length of their rights and may be shorter. Any legal, regulatory, or contractual provisions that enable renewal or extension of the assets legal or contractual life without substantial cost (provided there is evidence to support renewal or extension and renewal or extension can be accomplished without material modifications of the existing terms and conditions). Whether the cost of renewal is substantial shall be determined based on the relationship based on the relationship of the renewal cost to the fair value of the intangible asset at the time it is acquired. The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels). The level of maintenance expenditures required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life). As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not.
35-4
If no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an intangible asset to the reporting entity, the useful life of the asset shall be considered to be indefinite. The term indefinite does not mean the same as infinite or indeterminate. The useful life of an intangible asset is indefinite if that life extends beyond the foreseeable horizonthat is, there is no foreseeable limit on the period of time over which it is expected to contribute to the cash flows of the reporting entity. Such intangible assets might be airport route authorities, certain trademarks, and taxicab medallions.
CE12-3
According the FASB ASC 730-10-50: 50-1 Disclosure shall be made in the financial statements of the total research and development costs charged to expense in each period for which an income statement is presented.
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CE12-4
According the FASB ASC 926-720-25, General Overall Deals 25-1 An entity may enter into an overall deal arrangement. An entity shall charge the costs of overall deals that cannot be identified with specific projects to expenses as they are incurred over the related time period. > Exploitation Costs An entity shall account for advertising costs in accordance with the provisions of Subtopic 720-35-25-1; The costs of advertising shall be expensed either as incurred or the first time the advertising takes place. The accounting policy selected from these two alternatives shall be applied consistently to similar kinds of advertising activities. Deferring the costs of advertising until the advertising takes place assumes that the costs have been incurred for advertising that will occur. Such costs shall be expensed immediately if such advertising is not expected to occur. Examples of the first time advertising takes place include the first public showing of a television commercial for its intended purpose and the first appearance of a magazine advertisement for its intended purpose.
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ANSWERS TO QUESTIONS
1. The two main characteristics of intangible assets are: (a) they lack physical substance. (b) they are not a financial instrument. 2. If intangibles are acquired for stock, the cost of the intangible is the fair value of the consideration given or the fair value of the consideration received, whichever is more clearly evident. 3. Limited-life intangibles should be amortized by systematic charges to expense over their useful life. An intangible asset with an indefinite life is not amortized. 4. When intangibles are created internally, it is often difficult to determine the validity of any future service potential. To permit deferral of these types of costs would lead to a great deal of subjecttivity because management could argue that almost any expense could be capitalized on the basis that it will increase future benefits. The cost of purchased intangibles, however, is capitalized because its cost can be objectively verified and reflects its fair value at the date of acquisition. 5. Companies cannot capitalize self-developed, self-maintained, or self-created goodwill. These expenditures would most likely be reported as selling expenses. 6. Factors to be considered in determining useful life are: (a) The expected use of the asset by the entity. (b) The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate. (c) Any legal, regulatory, or contractual provisions that may limit useful life. (d) Any legal, regulatory or contractual provisions that enable renewal or extension of the assets legal or contractual life without substantial cost. (e) The effects of obsolescence, demand, competition, and other economic factors. (f) The level of maintenance expenditure required to obtain the expected future cash flows from the asset. 7. The amount of amortization expensed for a limited-life intangible asset should reflect the pattern in which the asset is consumed or used up, if that pattern can be reliably determined. If the pattern of production or consumption cannot be determined, the straight-line method of amortization should be used. 8. This trademark is an indefinite life intangible and, therefore, should not be amortized. 9. The $190,000 should be expensed as research and development expense in 2010. The $91,000 is expensed as selling and promotion expense in 2010. The $45,000 of costs to legally obtain the patent should be capitalized and amortized over the useful or legal life of the patent, whichever is shorter. 10. Patent Amortization Expense........................................................... Patents (or Accumulated Patent Amortization)........................... 35,000 35,000
Straight-line amortization is used because the pattern of use can not be reliably determined. 11. Artistic-related intangible assets involve ownership rights to plays, pictures, photographs, and video and audiovisual material. These ownership rights are protected by copyrights. 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.
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Questions Chapter 12 (Continued) 12. Varying approaches are used to define goodwill. They are (a) Goodwill should be measured initially as the excess of the fair value of the acquisition cost over the fair value of the net assets acquired. This definition is a measurement definition but does not conceptually define goodwill. (b) Goodwill is sometimes defined as one or more unidentified intangible assets and identifiable intangible assets that are not reliably measurable. Examples of elements of goodwill include new channels of distribution, synergies of combining sales forces, and a superior manage ment team. (c) Goodwill may also be defined as the intrinsic value that a business has acquired beyond the mere value of its net assets whether due to the personality of those conducting it, the nature of its location, its reputation, or any other circumstance incidental to the business and tending to make it permanent. Another definition is the capitalized value of the excess of estimated future profits of a business over the rate of return on capital considered normal in the industry. Negative goodwill develops when the fair value of the assets purchased is higher than the cost. This situation may develop from a market imperfection. In this case, the seller would have been better off to sell the assets individually than in total. However, situations do occur (e.g., a forced liquidation or distressed sale due to the death of the company founder), in which the purchase price is less than the value of the identifiable net assets. 13. Goodwill is recorded only when it is acquired by purchase. Goodwill acquired in a business combination is considered to have an indefinite life and therefore should not be amortized, but should be tested for impairment on at least an annual basis. 14. Many analysts believe that the value of goodwill is so subjective that it should not be given the same status as other types of assets such as cash, receivables, inventory, etc. The analysts are simply stating that they believe that presentation of goodwill on the balance sheet does not provide any useful information to the users of financial statements. Whether this is true or not is a difficult point to prove, but it should be noted that it appears contradictory to pay for the goodwill and then immediately write it off, denying that it has any value. 15. Accounting standards require that if events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, then the carrying amount of the asset should be assessed. The assessment or review takes the form of a recoverability test that compares the sum of the expected future cash flows from the asset (undiscounted) to the carrying amount. If the cash flows are less than the carrying amount, the asset has been impaired. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset. The fair value of assets is measured by their fair value if an active market for them exists. If no market price is available, the present value of the expected future net cash flows from the asset may be used. 16. Under U.S. GAAP, impairment losses on assets held for use may not be restored. 17. Impairment losses are reported as part of income from continuing operations, generally in the Other expenses and losses section. Impairment losses (and recovery of losses for assets to be disposed of) are similar to other costs that would flow through operations. Thus, gains (recoveries of losses) on assets to be disposed of should be reported as part of income from continuing operations. 18. The amount of goodwill impaired is $40,000, computed as follows: Recorded goodwill................................................. $400,000 Implied goodwill..................................................... 360,000 Impaired goodwill................................................... $ 40,000
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Questions Chapter 12 (Continued) 19. Research and development costs are incurred to develop new products or processes, to improve present products, or to discover new knowledge. R&D expenditures present problems of (1) identifying the costs associated with particular activities, projects, or achievements, and (2) determining the magnitude of the future benefits and the length of time over which such benefits may be realized. R&D activities may incur costs classified as follows: (a) materials, equipment, and facilities, (b) personnel, (c) purchased intangibles, (d) contract services, and (e) indirect costs. 20. (a) Personnel (labor) type costs incurred in R&D activities should be expensed as incurred. (b) Materials and equipment costs should be expensed immediately unless the items have alternative future uses. If the items have alternative future uses, the materials should be recorded as inventories and allocated as consumed and the equipment should be capitalized and depreciated as used. (c) Indirect costs of R&D activities should be reasonably allocated to R&D (except for general and administrative costs, which must be clearly related to be included) and expensed. 21. See Illustration 12-14. Type of 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Expenditure Construction of long-range research facility for use in current and future projects (threestory, 400,000-square-foot building). Acquisition of R&D equipment for use on current project only. Acquisition of machinery for use on current and future R&D projects. Purchase of materials for use on current and future R&D projects. Salaries of research staff designing new laser bone scanner. Research costs incurred under contract with New Horizon, Inc., and billable monthly. Material, labor, and overhead costs of prototype laser scanner. Costs of testing prototype and design modifications. Legal fees to obtain patent on new laser scanner. Executive salaries. Cost of marketing research to promote new laser scanner. Engineering costs incurred to advance the laser scanner to full production stage. Costs of successfully defending patent on laser scanner. Commissions to sales staff marketing new laser scanner. Accounting Treatment Capitalize and depreciate as R&D expense Expense immediately as R&D. Capitalize and depreciate as R&D expense. Inventory and allocate to R&D projects; expense as consumed. Expense immediately as R&D. Record as a receivable (reimbursable expenses). Expense immediately as R&D. Expense immediately as R&D. Capitalize as patent and amortize to overhead as part of cost of goods manufactured. Expense as operating expense (general and administrative). Expense as operating expense (selling). Expense immediately as R&D. Capitalize as patent and amortize to overhead as part of cost of goods manufactured. Expense as operating expense (selling).
(a) Expense as R&D.
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(b) Expense as R&D. (c) Capitalize as patent and/or license and amortize.
12-10
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Questions Chapter 12 (Continued) 22. Each of these items should be charged to current operations. Advertising costs have some minor exceptions to this general rule. However, the specific accounting is beyond the scope of this textbook. 23. $585,000 ($400,000 + $60,000 + $125,000). 24. These costs are referred to as start-up costs, or more specifically organizational costs in this case. The accounting for start up costs is straightforwardexpense these costs as incurred. The profession recognizes that these costs are incurred with the expectation that future revenues will occur or increased efficiencies will result. However, to determine the amount and timing of future benefits is so difficult that a conservative approachexpensing these costs as incurredis required. 25. The total life, per revised facts, is 40 years (10 + 30). There are 30 (40 10) remaining years for $540,000 amortization purposes. Original amortization: expired = $180,000 accumulated amortization. $540,000 180,000 $360,000 original cost accumulated amortization remaining cost to amortize 30 = $18,000 per year; $18,000 X 10 years
$360,000 30 years = $12,000 amortization for 2010 and years thereafter. 26. iGAAP related to intangible assets is presented in IAS 38, Intangible Assets. iGAAP related to impairments is found in IAS 36, Impairment of Assets. 27. Similarities include (1) in U.S. GAAP and iGAAP, the costs associated with research and development are segregated into the two components; (2) iGAAP and U.S. GAAP are similar for intangibles acquired in a business combination. That is, an intangible asset is recognized separately from goodwill if it represents contractual or legal rights or is capable of being separated or divided and sold, transferred, licensed, rented or exchanged; (3) Under both GAAPs, limited life intangibles are subject to amortization, but goodwill and indefinite life intangibles are not amortized; rather they are assessed for impairment on an annual basis; (4) iGAAP and U.S. GAAP are similar in the accounting for impairments of assets held for disposal. Notable differences are: (1) while costs in the research phase are always expensed under both iGAAP and U.S. GAAP, under iGAAP costs in the development phase are capitalized once technological feasibility is achieved; (2) iGAAP permits some capitalization of internally generated intangible assets (e.g., brand value), if it is probable there will be a future benefit and the amount can be reliably measured. U.S. GAAP requires expensing of all costs associated with internally generated intangibles; (3) iGAAP requires an impairment test at each reporting date for long-lived assets and intangibles and records an impairment if the assets carrying amount exceeds its recoverable amount; the recoverable amount is the higher of the assets 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 asset, discounted to present value. Under U.S. GAAP, impairment loss is measured as the excess of the carrying amount over the assets fair value; (4) iGAAP allows reversal of impairment losses when there has been a change in economic conditions or in the expected use of the asset. Under U.S. GAAP, impairment losses cannot be reversed for assets to be held and used; the impairment loss results in a new cost basis for the asset; (5) under iGAAP, acquired in-process research and development (IPR&D) is recognized as a separate intangible asset if it meets the definition of an intangible asset and its fair value can be measured reliably. U.S. requires acquired IPR&D to be
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written off.
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Questions Chapter 12 (Continued) 28. As shown in the analysis below, under iGAAP, Sophias ROA is overstated compared to a U.S. GAAP company. iGAAP Income Assets ROA (Income Assets) *( 1,125 + 120 325) ** 12, 500 + 120 325) ( 1,125 12,500 9% U.S. GAAP 920* 12,295** 7.5%
29. The IASB and FASB have identified a project relating to the accounting for research and development that could possibly converge iGAAP and U.S. GAAP on the issue of in-process R&D. One possibility is to amend U.S. GAAP to allow capitalization of in-process R&D similar to the provisions in iGAAP. A second project, in a very preliminary stage, would consider expanded recognition of internally generated intangible assets. As indicated, iGAAP permits more recognition of intangibles compared to U.S. GAAP. Thus, it will be challenging to develop converged standards for intangible assets, given the long-standing prohibition on capitalizing intangible assets and research and development in U.S. GAAP. Learn more about the timeline for the intangible asset project at the IASB web-site: http://www.iasb.org/Current+Projects/IASB+Work+Plan.htm *30. The professions position is that costs incurred internally in creating a computer software product to be sold should be charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detailed program design or, in its absence, completion of a working model. Thereafter, all software costs should be capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to straight-line amortization over the remaining estimated economic life of the product.
*31. Under the percent of revenue approach, $900,000 would be reported; under the straight-line approach, $1,125,000 would be reported. Because the straightline approach is higher, $1,125,000 should be reported as R&D expense for this product. *32. Expensing the development cost in the current year is appropriate when the costs are classified as research and development costs and the computer software is to be sold, leased, or marketed to third parties. Capitalizing the development cost of the software package over its estimated useful life is appropriate if the costs are subsequent to achieving technological feasibility and future benefits are reasonably certain. Stakeholders (users of financial statements or parties affected by financial statements) may be harmed whenever expenses and revenues are mismatched. Inappropriate recognition of development costs can harm all parties involved due to any understatement and overstatement of income.
$2,000,000 $4,500,000 X $2,000,000 + $8,000, 000
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 12-1 Patents....................................................................... Cash.................................................................. Patent Amortization Expense.................................. Patents ($54,000 X 1/10 = $5,400)................... 54,000 54,000 5,400 5,400
BRIEF EXERCISE 12-2 Patents....................................................................... Cash.................................................................. Patent Amortization Expense.................................. Patents [($43,200 + $24,000) X 1/8 = $8,400]. . . 24,000 24,000 8,400 8,400
BRIEF EXERCISE 12-3 Trade Name................................................................ Cash.................................................................. Trade Name Amortization Expense......................... Trade Name ($68,000 X 1/8 = $8,500)............. 68,000 68,000 8,500 8,500
BRIEF EXERCISE 12-4 Franchise....................................................................... Cash...................................................................... Franchise Amortization Expense................................ Franchise ($120,000 X 1/8 X 9/12 = $11,250)..... 120,000 120,000 11,250 11,250
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BRIEF EXERCISE 12-5 Purchase price.............................................................. Fair value of assets...................................................... Fair value of liabilities.................................................. Fair value of net assets................................................ Value assigned to goodwill......................................... $700,000 $800,000 200,000 600,000 $100,000
BRIEF EXERCISE 12-6 Loss on Impairment...................................................... Patents ($300,000 $110,000)............................ 190,000 190,000
Note: An impairment has occurred because expected net future cash flows ($210,000) are less than the carrying amount ($300,000). The loss is measured as the difference between the carrying amount and fair value ($110,000).
BRIEF EXERCISE 12-7 Because the fair value of the division exceeds the carrying amount of the assets, goodwill is not considered to be impaired. No entry is necessary.
BRIEF EXERCISE 12-8 Loss on Impairment ($400,000 $350,000)............ Goodwill............................................................ 50,000 50,000
The fair value of the reporting unit ($750,000) is less than the carrying value ($800,000)an impairment has occurred. The loss is the difference between the recorded goodwill and the implied goodwill.
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BRIEF EXERCISE 12-9 Organization Cost Expense..................................... Cash.................................................................. 60,000 60,000
BRIEF EXERCISE 12-10 Research and Development Expense..................... Cash.................................................................. 430,000 430,000
BRIEF EXERCISE 12-11 (a) (b) (c) (d) Capitalize Expense Expense Expense
BRIEF EXERCISE 12-12 Carrying Amount Patent (1/1/10) $288,000 Legal costs (12/1/10) 85,000 $373,000 Life in Months 96 85 Amortization Per Month $3,000 $1,000 Months Amortization 12 1
Carrying amount........................................................ Less: Amortization of patent (12 X $3,000)............ Legal costs amortization (1 X $1,000).......... Carrying amount 12/31/10.........................................
$373,000 (36,000) (1,000) $336,000
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BRIEF EXERCISE 12-13 Copyright No. 1 for $9,900 should be expensed and therefore not reported on the balance sheet. Copyright No. 2 for $24,000 should be capitalized. Because the useful life is indefinite, copyright No. 2 should be tested at least annually for impairment using a fair value test. It would be reflected on the December 31, 2010 balance sheet at its cost of $24,000.
*BRIEF EXERCISE 12-14 Percent of revenue approach $800,000 X $420,000 $1,400,000* *($420,000 + $980,000) Straight-line approach $800,000 X 1/4 = $200,000 Amortization is $240,000; percentage of revenue is greater. = $240,000
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SOLUTIONS TO EXERCISES
EXERCISE 12-1 (1520 minutes) (a) (b) 10, 13, 15, 16, 17, 19, 23 1. Long-term investments in the balance sheet. 2. Property, plant, and equipment in the balance sheet. 3. Research and development expense in the income statement. 4. Current asset (prepaid rent) in the balance sheet. 5. Property, plant, and equipment in the balance sheet. 6. Research and development expense in the income statement. 7. Charge as expense in the income statement. 8. Operating losses in the income statement. 9. Charge as expense in the income statement. 11. Not recorded; any costs related to creating goodwill incurred internally must be expensed. 12. Research and development expense in the income statement. 14. Research and development expense in the income statement. 18. Research and development expense in the income statement. 20. Research and development expense in the income statement. 21. Long-term investments, or other assets, in the balance sheet. 22. Expensed in the income statement.
EXERCISE 12-2 (1015 minutes) The following items would be classified as an intangible asset: Cable television franchises Film contract rights Music copyrights Customer lists Goodwill Covenants not to compete Internet domain name Brand names Cash, accounts receivable, notes receivable, and prepaid expenses would be classified as current assets.
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Property, plant, and equipment, and land would be classified as noncurrent assets in the property, plant, and equipment section.
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EXERCISE 12-2 (Continued) Investments in affiliated companies would be classified as part of the investments section of the balance sheet. Research and development costs would be classified as an operating expense. Discount on notes payable is shown as a deduction from the related notes payable on the balance sheet. Organization costs are start-up costs and should be expensed as incurred.
EXERCISE 12-3 (1015 minutes) (a) Trademarks.......................................................................... Excess of cost over fair value of net identifiable assets of acquired subsidiary (goodwill)...................... Total intangible assets....................................................... Organization costs, $24,000, should be expensed. Discount on bonds payable, $35,000, should be reported as a contra account to bonds payable in the long-term liabilities section. Deposits with advertising agency for ads to promote goodwill of company, $10,000, should be reported either as an expense or as prepaid advertising in the current assets section. Advertising costs in general are expensed when incurred or when first used. Cost of equipment acquired for research and development projects, $90,000, should be reported with property, plant, and equipment, because the equipment has an alternative use. Costs of developing a secret formula for a product that is expected to be marketed for at least 20 years, $70,000, should be classified as research and development expense on the income statement. $20,000 75,000 $95,000
(b)
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EXERCISE 12-4 (1520 minutes) 1. Palmiero should report the patent at $900,000 (net of $600,000 accumulated amortization) on the balance sheet. The computation of accumulated amortization is as follows. Amortization for 2008 and 2009 ($1,500,000/10) X 2......... 2010 amortization: ($1,500,000 $300,000) (6 2)........ Accumulated amortization, 12/31/10.................................. $300,00 0 300,00 0 $600,00 0
2.
Palmiero should amortize the franchise over its estimated useful life. Because it is uncertain that Palmiero will be able to retain the franchise at the end of 2018, it should be amortized over 10 years. The amount of amortization on the franchise for the year ended December 31, 2010, is $35,000: ($350,000/10). These costs should be expensed as incurred. Therefore $275,000 of organization expense were reported in income for 2008. Because the license can be easily renewed (at nominal cost), it has an indefinite life. Thus, no amortization will be recorded. The license will be tested for impairment in future periods.
3.
4.
EXERCISE 12-5 (1520 minutes) Research and Development Expense............................. Patents................................................................................ Rent Expense [(5 7) X $91,000]..................................... Prepaid Rent [(2 7) X $91,000]....................................... Advertising Expense......................................................... Income Summary (or a loss account)............................. Discount on Bonds Payable............................................. Interest Expense................................................................ Paid in Capital in Excess of Par on Common Stock. . . Intangible Assets........................................................ 940,000 75,000 65,000 26,000 207,000 141,000 82,950* 1,050 250,000 1,288,00 0
*84,000 240 months = $350; $350 X 3 = $1,050; $84,000 $1,050 = $82,950
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
Patent Amortization Expense [($75,000 12) X 1/2]...... Patents (or Accumulated Amortization)................
3,125 3,125
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EXERCISE 12-6 (1520 minutes) Patents.................................................................... Goodwill.................................................................. Franchise................................................................ Copyright................................................................ Research and Development Expense................. Intangible Assets.......................................... Amortization Expense........................................... Patents ($380,000/8)..................................... Franchise ($450,000/10 X 6/12)................... Copyright ($156,000/5 X 5/12)..................... Balance of Intangible Assets as of December 31, 2010 Patents = $380,000 $47,500 = $332,500 Goodwill = $360,000 (no amortization) Franchise = $450,000 $22,500 = $427,500 Copyright = $156,000 $13,000 = $143,000 380,000 360,000 450,000 156,000 215,000 1,561,000 83,000 47,500 22,500 13,000
EXERCISE 12-7 (1015 minutes) (a) 2009 amortization: $18,000 10 = $1,800. 12/31/09 book value: $18,000 $1,800 = $16,200. 2010 amortization: ($16,200 + $7,800) 9 = $2,667. 12/31/10 book value: ($16,200 + $7,800 $2,667) = $21,333. (b) 2010 amortization: ($16,200 + $7,800) 4 = $6,000. 12/31/10 book value: $16,200 + $7,800 $6,000 = $18,000. Carrying amount ($21,333) > future cash flows ($17,000); thus the trade name fails the recoverability test. The new carrying value is $16,000the trade names fair value. 2011 amortization (after recording impairment loss): $16,000 8 = $2,000. 12/31/11 book value: $16,000 $2,000 = $14,000.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
(c)
EXERCISE 12-8 (1015 minutes) (a) Attorneys fees in connection with organization of the company................................................................ Costs of meetings of incorporators to discuss organizational activities.................................................. State filing fees to incorporate.......................................... Total organization costs....................................................
$17,000 7,000 1,000 $25,000
Drafting and design equipment, $10,000, should be classified as part of fixed assets, rather than as organization costs. (b) Organization Cost Expense.................................. Cash (Payables)........................................... 25,000 25,000
EXERCISE 12-9 (1520 minutes) (a) DEVON HARRIS COMPANY Intangibles Section of Balance Sheet December 31, 2010 $1,800,000 522,000 $2,322,000
Patent from Bradtke Company, net of accumulated amortization of $700,000 (Schedule 1)................................... Franchise from Greene Company, net of accumulated amortization of $58,000 (Schedule 2)..................................... Total intangibles.......................................................................... Schedule 1Computation of Patent from Bradtke Company Cost of patent at date of purchase............................................. Amortization of patent for 2009 ($2,500,000 10 years)...........
Amortization of patent for 2010 ($2,250,000 5 years)............. Patent balance...............................................................................
$2,500,000 (250,000 ) 2,250,000 (450,000 ) $1,800,000
Schedule 2Computation of Franchise from Greene Company Cost of franchise at date of purchase........................................ $ 580,000 Amortization of franchise for 2010 ($580,000 10)................... (58,000
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Franchise balance.........................................................................
) $ 522,000
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EXERCISE 12-9 (Continued) (b) DEVON HARRIS COMPANY Income Statement Effect For the Year Ended December 31, 2010 Patent from Bradtke Company: Amortization of patent for 2010 ($2,250,000 5 years).................................. Franchise from Greene Company: Amortization of franchise for 2010 ($580,000 10)............................................. Payment to Greene Company ($2,500,000 X 5%)......................................... Research and development costs...................... Total charged against income.......................
$ 450,000
$ 58,000 125,000 183,000 433,000 $1,066,000
EXERCISE 12-10 (1520 minutes) (a) 2007 Research and Development Expense... Cash................................................. Patents...................................................... Cash................................................. Patent Amortization Expense................. Patents [($24,000 10) X 3/12]...... 2008 Patent Amortization Expense................. Patents ($24,000 10).................... 170,000 170,000 24,000 24,000 600 600 2,400 2,400
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EXERCISE 12-10 (Continued) (b) 2009 Patents.............................................................. Cash........................................................ Patent Amortization Expense........................ Patents ($1,000 + $1,575)...................... [Jan. 1June 1: ($24,000 10) X 5/12 = $1,000 June 1Dec. 31: ($24,000 $600 $2,400 $1,000 + $12,400) = $32,400; ($32,400 12) X 7/12 = $1,575] 2010 Patent Amortization Expense........................ Patents ($32,400 12)............................ (c) 2011 and 2012 Patent Amortization Expense........................ Patents ($28,125 2).............................. ($32,400 $1,575 $2,700) = $28,125 12,400 12,400 2,575 2,575
2,700 2,700
14,063 14,063
EXERCISE 12-11 (a) Patent A Life in years................................................................ Life in months (12 X 17)............................................ Amortization per month ($40,800 204).................. Number of months amortized to date Year Month 10 2006 12 2007 12 2008 12 2009 46 Book value 12/31/09 $31,600: ($40,800 [46 X $200])
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17 204 $200
EXERCISE 12-11 (Continued) Patent B Life in years............................................................ Life in months (12 X 10)........................................ Amortization per month ($15,000 120)............. Number of months amortized to date Year Month 6 2007 2008 2009 12 12 30 Book value 12/31/09 $11,250: ($15,000 [$125 X 30]) Patent C Life in years............................................................ Life in months (12 X 4).......................................... Amortization per month ($14,400 48)............... Number of months amortized to date Year Month 4 2008 12 2009 16 Book value 12/31/09 $9,600: ($14,400 [$300 X 16]) At December 31, 2009 Patent A......................................................... Patent B......................................................... Patent C......................................................... Total........................................................................
10 120 $125
4 48 $300
$31,600 11,250 9,600 $52,450
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EXERCISE 12-11 (Continued) (b) Analysis of 2010 transactions 1. The $245,700 incurred for research and development should be expensed. The book value of Patent B is $11,250 and its estimated future cash flows are $6,000: (3 X $2,000); therefore Patent B is impaired. The impairment loss is imputed as follows: Book value........................................................ Less: Present value of future cash flows ($2,000 X 2.57710)............. Loss recognized............................................... Patent B carrying amount (12/31/10) $5,154 At December 31, 2010 Patent A $29,200 ($31,600 [12 X $200]) Patent B 5,154 (Present value of future cash flows) Patent C 6,000 ($9,600 [12 X $300]) Patent D 27,000 ($28,500 $1,500*) Total $67,354 *Patent D amortization Life in years Life in months Amortization per month ($28,500 114) $250 X 6 = $1,500 $11,250 5,154 $ 6,096
2.
9 1/2 114 $250
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 12-12 (2025 minutes) Net assets of Terrell as reported................................. Adjustments to fair value Increase in land value......................................... Decrease in equipment value............................. Net assets of Terrell at fair value................................ Selling price.................................................................. Amount of goodwill to be recorded............................ $225,000 50,000 (5,000)
45,000 270,000 380,000 $110,000
The journal entry to record this transaction is as follows: Cash............................................................................... Land............................................................................... Building.......................................................................... Equipment..................................................................... Copyright....................................................................... Goodwill......................................................................... Accounts Payable............................................... Long-term Notes Payable................................... Cash...................................................................... 100,000 120,000 200,000 170,000 30,000 110,000 50,000 300,000 380,000
EXERCISE 12-13 (1015 minutes) (a) Cash...................................................................... ............................................................................... Receivables......................................................... Inventory.............................................................. Land ..................................................................... Buildings.............................................................. Equipment............................................................ Trademarks.......................................................... Goodwill............................................................... Accounts Payable...................................... Notes Payable............................................ Cash............................................................ 50,000 90,000 125,000 80,000 75,000 70,000 15,000 95,000* 200,000 150,000 250,000
*$400,000 [$235,000 + $40,000 + $25,000 + $5,000] Note that the building and equipment would be recorded at the 7/1/10
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cost to Brandon; accumulated depreciation accounts would not be recorded.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 12-13 (Continued) (b) Trademark Amortization Expense........................... Trademarks ([$15,000 $3,000] X 1/4 X 6/12)... 1,500 1,500
EXERCISE 12-14 (1520 minutes) (a) December 31, 2010 Loss on Impairment........................................... Copyrights................................................. *Carrying amount...................... Fair value.................................. Loss on impairment................. $4,300,000 3,400,000 $ 900,000
900,000* 900,000
Note: Asset fails recoverability test, future cash flows ($4,000,000) < carrying amount ($4,300,000). (b) Copyright Amortization Expense..................... Copyrights................................................. *New carrying amount.............. Useful life.................................. Amortization per year.............. (c) $3,400,000 10 years $ 340,000 340,000* 340,000
No entry is necessary. Restoration of any impairment loss is not permitted for assets held for use.
EXERCISE 12-15 (1520 minutes) (a) December 31, 2010 Loss on Impairment............................... 25,000,000 Goodwill.........................................
25,000,000
The fair value of the reporting unit ($335 million) is below its carrying value ($360 million). Therefore, an impairment has occurred. To determine the impairment amount, we first find the implied goodwill. We then compare this implied fair value to the carrying value of the goodwill to determine the amount of the impairment to record.
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EXERCISE 12-15 (Continued) Fair value of division........................................................ Carrying amount of division, net of goodwill................. Implied value of goodwill................................................. Carrying value of goodwill............................................... Loss on impairment.......................................................... (b) $335,000,000 160,000,000 175,000,000 (200,000,000) $ 25,000,000
No entry necessary. After a goodwill impairment loss is recognized, the adjusted carrying amount of the goodwill is its new accounting basis. Subsequent reversal of previously recognized impairment losses is not permitted under SFAS No. 142.
EXERCISE 12-16 (1520 minutes) (a) In accordance with FASB Statement No. 2, the $325,000 is a research and development cost that should be charged to R&D Expense and, if not separately disclosed in the income statement, the total cost of R&D should be separately disclosed in the notes to the financial statements. Research and Development Expense.......... Cash, Accts. Payable, etc..................... (To record research and development costs) Patents............................................................. Cash, Accts. Payable, etc..................... (To record legal and administrative costs incurred to obtain patent #472-1001-84) Patent Amortization Expense........................ Patents................................................... [To record one years amortization expense ($24,000 5 = $4,800)]
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(b)
130,000 130,000
24,000 24,000
4,800 4,800
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 12-16 (Continued) (c) Patents................................................................ Cash, Accts. Payable, etc........................ (To record legal cost of successfully defending patent) 47,200 47,200
The cost of defending the patent is capitalized because the defense was successful and because it extended the useful life of the patent. Patent Amortization Expense........................... Patents....................................................... (To record one years amortization Expense: $24,000 $4,800 = $19,200; $19,200 8 = $2,400 $47,200 8 = 5,900 Amortization expense for 2011 $8,300 Or Carrying value after 1 year $19,200 Cost to defend 47,200 $66,400 Expense: $66,400 8 = $8,300 (d) 8,300 8,300
Additional engineering and consulting costs required to advance the design of a product to the manufacturing stage are R&D costs. As indicated in the chapter it is R&D because it translates knowledge into a plan or design for a new product.
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EXERCISE 12-17 (1012 minutes) Depreciation of equipment acquired that will have alternate uses in future research and development projects over the next 5 years ($330,000 5)..................................................... Materials consumed in research and development projects....... Consulting fees paid to outsiders for research and development projects.................................................................... Personnel costs of persons involved in research and development projects.................................................................... Indirect costs reasonably allocable to research and development projects.................................................................... Total to be expensed in 2010 for research and Development.........................................................................
$ 66,000 59,000 100,000 128,000 50,000 $403,000*
*Materials purchased for future R&D projects should be reported as an asset.
*EXERCISE 12-18 (1015 minutes) (a) Companies are required to use the greater of (1) the ratio of current revenues to current plus anticipated revenues (percent of revenue approach) or (b) the straight-line method over the remaining useful life of the asset to amortize capitalized computer software costs. Percent of revenue approach: $2,000,000 X $3,900,000 = $650,000 $12,000,000
(b)
Straight-line method: 1/5 X $3,900,000 = $780,000 Amortization for 2010 would be $780,000 by the straight-line method because it results in the greater amount.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
*EXERCISE 12-19 (1520 minutes) (a) Research and Development Expense................. 2,600,000 2,600,000 Cash................................................................. Computer Software Costs ($5,000,000 $2,600,000)................................... 2,400,000 2,400,000 Cash................................................................. (b) Amortization Expense (20% X $2,400,000)......... Computer Software Costs............................. (Percent of revenue, $3,200,000/ $16,000,000 = 20%; 20% X $2,400,000 = $480,000; straight-line, 1/8 X $2,400,000 = $300,000; use percent of revenue approach because its greater than straight-line, 1/8 = 12.5%) 480,000 480,000
(c)
The computer software costs should be reported in the 12/31/11 balance sheet at unamortized cost ($2,400,000 $480,000 = $1,920,000) unless net realizable value is lower. Botosan Enterprises should disclose in its December 31, 2011, financial statements the unamortized computer software costs included in the balance sheet presented, and the total amount charged to expense in the income statement presented for amortization of capitalized computer software costs and for amounts written down to net realizable value. The accounting guidance in this area applies only to the development of computer software that is to be sold, leased, or otherwise marketed to third parties. No authoritative literature specifically addresses the issue of computer software developed for internal use. In practice, such costs are generally expensed as incurred. Therefore, the total of $5,000,000 would be expensed in (a), there would be no amortization in (b), and computer software costs would not be reported on the balance sheet in (c).
(d)
(e)
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TIME AND PURPOSE OF PROBLEMS
Problem 12-1 (Time 1520 minutes) Purposeto provide the student with an opportunity to appropriately reclassify amounts charged to a single intangible asset account. Capitalized in the account are amounts representing franchise costs, prepaid rent, organization fees, prior net loss, patents, goodwill, and R&D costs. The student must also be alert to the fact that several transactions require that an adjustment of Retained Earnings be made. The problem provides a good summary of accounting for intangibles. Problem 12-2 (Time 2030 minutes) Purposeto provide the student with an opportunity to compute the carrying value of a patent at three balance sheet dates. The student must distinguish between expenditures that are properly included in the patent account and R&D costs which must be expensed as incurred. Computation of amortization is slightly complicated by additions to the account and a change in the estimated useful life of the patents. A good summary of accounting for patents and R&D costs. Problem 12-3 (Time 2030 minutes) Purposethe student determines the cost and amortization of a franchise, patent, and trademark and shows how they are disclosed on the balance sheet. The student prepares a schedule of expenses resulting from the intangibles transactions. Problem 12-4 (Time 1520 minutes) Purposeto provide the student with an opportunity to determine income statement and balance sheet presentation for costs related to research and development of patents. The problem calls on the student to determine whether costs incurred are properly capitalized or expensed. The problem addresses the basic issues involved in accounting for R&D costs and patents. Problem 12-5 (Time 2530 minutes) Purposeto provide the student with an opportunity to determine the amount of goodwill in a business combination and to determine the goodwill impairment. Problem 12-6 (Time 3035 minutes) Purposeto provide the student with an opportunity to determine carrying value of intangible assets (limited life, indefinite life, and goodwill) at two balance sheet dates. The problem also requires students to determine impairments, if necessary on the intangible assets.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
SOLUTIONS TO PROBLEMS
PROBLEM 12-1
Franchises..................................................................... Prepaid Rent.................................................................. Retained Earnings (Organization Costs of $6,000 in 2009)........................................................... Retained Earnings ($16,000 $6,000)........................ Patents ($84,000 + $12,650)......................................... Research and Development Expense ($75,000 + $160,000).................................................. Goodwill......................................................................... Intangible Assets................................................. Franchise Amortization Expense ($48,000 8)......... Retained Earnings ($48,000 8 X 6/12)...................... Franchises............................................................ Rent Expense ($24,000 2)......................................... Retained Earnings ($24,000 2 X 3/12)...................... Prepaid Rent........................................................ Patent Amortization Expense...................................... Patents.................................................................. ($84,000 10) + ($12,650 X 7/115)
48,000 24,000 6,000 10,000 96,650 235,000 278,400 698,050 6,000 3,000 9,000 12,000 3,000 15,000 9,170 9,170
Note: No amortization of goodwill; goodwill should be tested for impairment on at least an annual basis in future periods.
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PROBLEM 12-2 (a) Costs to obtain patent Jan. 2004.................. 2004 amortization ($59,500 17).................. Carrying value, 12/31/04................................ $59,500 (3,500) $56,000
All costs incurred prior to January 2004 are related to research and development activities and were expensed as incurred in accordance with GAAP. (b) 1/1/05 carrying value of patent...................... 2005 amortization ($59,500 17).................. 2006 amortization........................................... Legal fees to defend patent 12/06................. Carrying value, 12/31/06................................ 2007 amortization ($91,000 14).................. 2008 amortization........................................... Carrying value, 12/31/08................................ $56,000 $3,500 3,500 (7,000) 49,000 42,000 91,000 (13,000) $78,000
6,500 6,500
The costs incurred in 2005 and 2007 are related to research and development activities and are expensed as incurred. (c) 1/1/09 carrying value...................................... 2009 amortization ($78,000 5)..................... 2010 amortization........................................... 2011 amortization........................................... Carrying value, 12/31/11................................ $78,000 $15,600 15,600 15,600
(46,800) $31,200
The legal costs in 2011 were expensed because the suit was unsuccessful.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 12-3
(a)
SANDRO CORPORATION Intangible Assets December 31, 2010 $ 52,830 15,400 39,600 $107,830
Franchise, net of accumulated amortization of $5,870 (Schedule 1).................................................................................. Patent, net of accumulated amortization of $2,200 (Schedule 2).................................................................................. Trademark, net of accumulated amortization of $6,600 (Schedule 3).................................................................................. Total intangible assets.......................................................... Schedule 1 Franchise Cost of franchise on 1/1/10 ($15,000 + $43,700).......................... 2010 amortization ($58,700 X 1/10)................................................ Cost of franchise, net of amortization................................. Schedule 2 Patent Cost of securing patent on 1/2/10................................................. 2010 amortization ($17,600 X 1/8).................................................. Cost of patent, net of amortization...................................... Schedule 3 Trademark Cost of trademark on 7/1/07........................................................... Amortization, 7/1/07 to 7/1/10 ($36,000 X 3/20)............................ Book value on 7/1/10...................................................................... Cost of successful legal defense on 7/1/10.................................. Book value after legal defense...................................................... Amortization, 7/1/10 to 12/31/10 ($40,800 X 1/17 X 6/12)............. Cost of trademark, net of amortization...............................
$ 58,700 (5,870) $ 52,830
$ 17,600 (2,200) $ 15,400
$ 36,000 (5,400) 30,600 10,200 40,800 (1,200) $ 39,600
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PROBLEM 12-3 (Continued) (b) SANDRO CORPORATION Expenses Resulting from Selected Intangible Assets Transactions For the Year Ended December 31, 2010 $ 6,118 5,870 45,000 2,200 2,100 $61,288
Interest expense ($43,700 X 14%)................................................. Franchise amortization (Schedule 1)............................................ Franchise fee ($900,000 X 5%)....................................................... Patent amortization (Schedule 2).................................................. Trademark amortization (Schedule 4)........................................... Total intangible assets..........................................................
Note: The $65,000 of research and development costs incurred in developing the patent would have been expensed prior to 2010. Schedule 4 Trademark Amortization Amortization, 1/1/10 to 6/30/10 ($36,000 X 1/20 X 6/12)............... Amortization, 7/1/10 to 12/31/10 ($40,800 X 1/17 X 6/12)............. Total trademark amortization...............................................
$ 900 1,200 $2,100
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 12-4 (a) Income statement items and amounts for the year ended December 31, 2010: Research and development expenses*........................... Amortization of patent ($88,000 10 years).................... $288,000 8,800
*The research and development expenses could be listed by the components rather than in one total. The detail of the research and development expenses are as follows: Depreciationbuilding ($320,000 20 years)....................................................... Salaries and employee benefits........................................ Other expenses.................................................................. (b) Balance sheet items and amounts as of December 31, 2010: Land..................................................................................... .............................................................................................. Building (net of accumulated depreciation of $16,000)........................................................................ Patent (net of amortization of $15,400)*........................... *([$88,000 10] X 3/4) + ($88,000 10) All research and development costs should be charged to expense when incurred. Therefore, all of Robin Wright Tool Companys costs related to its research and development activities for 2010 would be expensed regardless of the long-term benefits. The patent was acquired for manufacturing rights rather than for use in research and development activities. Consequently, the cost of the patent can be capitalized as an intangible asset and amortized over its useful life. $ 60,000
$ 16,000 195,000 77,000
304,000 72,600
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PROBLEM 12-5
(a)
Goodwill = Excess of the cost of the division over the fair value of the identifiable assets: $3,000,000 $2,750,000 = $250,000
(b)
No impairment loss is recorded, because the fair value of Conchita ($1,850,000) is greater than carrying value of the net assets ($1,650,000). Computation of impairment: Implied fair value of goodwill = Fair value of division less the carrying value of the division (adjusted for fair value changes), net of goodwill: Fair value of Conchita division.................... Carrying value of division............................ Increase in fair value of PP&E..................... Less: Goodwill.............................................. Implied fair value of goodwill....................... Carrying value of goodwill........................... Impairment loss............................................. $1,600,000 $1,650,000 150,000 (250,000) (1,550,000) 50,000 (250,000) ($ 200,000) $200,000 200,000
(c)
(d)
Loss on Impairment...................................... Goodwill.................................................
This loss will be reported in income as a separate line item before the subtotal income from continuing operations.
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PROBLEM 12-6 (a)
MONTANA MATTS GOLF INC. Intangibles Section of Balance Sheet December 31, 2009 $ 10,000 23,700 170,000 $203,700
Trade name...................................................................................... Copyright (net accumulated amortization of $300) (Schedule 1).................................................................................. Goodwill (Schedule 2)..................................................................... Total intangibles.............................................................................. Schedule 1Computation of Value of Old Master Copyright Cost of copyright at date of purchase.......................................... Amortization of Copyright for 2009 [($24,000 40) X 1/2 year]..... Cost of copyright at December 31....................................... Schedule 2Goodwill Measurement Purchase price.......................................................... Fair value of assets................................................... Fair value of liabilities.............................................. Fair value of net assets.................................. Value assigned to goodwill......................................
$ 24,000 (300) $ 23,700
$770,000 $800,000 (200,000) 600,000 $170,000
Amortization expense for 2009 is $300 (see Schedule 1). There is no amortization for the goodwill or the trade name, both of which are considered indefinite life intangible assets. (b) Copyright Amortization Expense..................... Copyright ($24,000 40)................................ 600 600
There is a full year of amortization on the Copyright. There is no amortization for the goodwill or the trade name, which is considered an indefinite life intangible.
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PROBLEM 12-6 (Continued) MONTANA MATTS GOLF INC. Intangibles Section of Balance Sheet December 31, 2010 Trade name........................................................................................ Copyright (net accumulated amortization of $900) (Schedule 1).................................................................................... Goodwill.............................................................................................. Total intangibles................................................................................ Schedule 1Computation of Value of Old Master Copyright Cost of Copyright at date of purchase............................................ Amortization of Copyright for 2009, 2010 [($24,000 40) X 1.5 years]............................................................ Cost of copyright at December 31......................................... $ 10,000 23,100 170,000 $203,100
$ 24,000 (900 ) $ 23,100
(c) Loss on Impairment..................................................... Goodwill ($170,000 $90,000*)................................ Trade name ($10,000 $3,000)................................ *Fair value of Old Master reporting unit.......... $420,000 Net identifiable assets (excluding goodwill) ($500,000 $170,000)..................................... (330,000) Implied value of goodwill.................................. $ 90,000
87,000 80,000 7,000
The Goodwill is considered impaired because the fair value of the business unit ($420,000) is less than its carrying value ($500,000). The copyright is not considered impaired because the expected net future cash flows ($30,000) exceed the carrying amount ($24,000).
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TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 12-1 (Time 2530 minutes) Purposeto provide the student with an opportunity to discuss the conceptual merits and reporting requirements of three methods of accounting for a penalty assessment. The student is required to evaluate the merits of expensing the item currently, treating it as a prior period adjustment, or capitalizing the amount of the penalty and amortizing it over future periods. This case presents a good illustration of a realistic situation in which the accountant faces the question of capitalizing or expensing an expenditure . It should be emphasized that a thorough justification for each method should be presented. CA 12-2 (Time 2025 minutes) Purposeto provide the student with an opportunity to determine the proper classification of certain expenditures related to organizing a business. The student is required to deal with such issues as costs incurred for interest expense during construction, the cost of promotional advertising, and expenditures related to obtaining tenants for a shopping center. Classification of these items is complicated due to a postponement in the starting of business operations. A challenging and interesting case which should provide good background for a discussion of the theoretical support for capitalizing organization costs. CA 12-3 (Time 2530 minutes) Purposeto present an opportunity for the student to discuss accounting for patents from a theoretical and a practical viewpoint. The student is required to explain the discounted value of expected net receipts method of accounting for patents and to provide support for using cost as the generally accepted valuation method. The student is also required to comment on the theoretical basis of patent amortization. Finally the student must determine proper disclosure in the financial statements for a patent infringement suit which is in progress at the balance sheet date. This case challenges the student to present theoretical support and practical application beyond that presented in the text. CA 12-4 (Time 2530 minutes) Purposeto provide the student with an opportunity to discuss the theoretical support for and practical applications of the FASBs position on research and development costs. The student is required to define the terms research and development as used by the FASB in Statement No. 2, to provide theoretical support for the FASBs position, and to apply the provisions of Statement No. 2 to a situation presented in the case. A good case to thoroughly cover research and development costs. CA 12-5 (Time 2025 minutes) Purposeto provide the student with an opportunity to examine the ethical issues related to expensing research and development costs.
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SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 12-1
(a) Accounting for the penalty as a charge to the current period is justified if the penalty is considered the result of an unusual event (the assessment) occurring within the period. The penalty may be an extraordinary item rather than a part of income before extraordinary items, if it is material and is unusual in nature and infrequent in occurrence. Installation of the air pollution control equipment should prevent the assessment of further penalties. (b) Accounting for the penalty as a correction of prior periods is justified if the penalty is considered a result of the business activities of prior periods, rather than a result of an event of the current and future periods. The penalty is assessed to correct damage which occurred as a result of production of prior periods and thus represents a cost of production which was omitted from the reported results of those prior periods. Further justification is provided by the fact that determination of the amount of the penalty was presumably made by someone other than management (the Pollution Control Agency) and could not be reasonably estimated before determination. A prior period adjustment should be reported as an adjustment of the current years beginning balance of retained earnings, as previously reported. If statements of prior periods are presented, they should be restated to include in income before extraordinary items the portion of the penalty allocable to each period, with appropriate adjustments to other items affected, such as retained earnings, liabilities, and earnings per share. (c) Accounting for the penalty as a capitalizable item to be amortized over future periods is justified if the penalty is viewed as a payment made to benefit future periods. If the penalty is not paid, Counting Crows Company will not be allowed to operate in future periods; thus, the penalty is similar to a license to do business. Since the amortized expense will recur from period to period, it should be included in income before extraordinary items. Amortization should be computed in a rational and systematic manner.
CA 12-2
Interest on mortgage bonds. An amount equal to the interest cost incurred in 2009 ($720,000) is a cost which can be associated with the normal construction period and can be regarded as a normal element of the cost of the physical assets of the shopping center because the construction period would have ended at the end of the year if the tornado had not occurred. The decision to use debt capital to finance the shopping center was made with full knowledge that interest would accrue during the construction period and add to the total cost of building the center, bringing it to the point at which it would produce revenue. The future income to be generated by the shopping center must have been estimated to be more than sufficient to recover all of the expected costs of building the center and preparing it for occupancy, including interest during the construction period. In lieu of treating interest during construction as an element of the cost of the physical assets, it can be argued that it represents an element of the general cost of bringing the business to the point of revenue production and should therefore be treated as an organization expense. This view regards interest during construction as just another of the many expenditures that are necessary to acquire and organize the physical assets of a new business but do not attach to any specific assets. Note that interest must be capitalized in this situation (see chapter 10) because the building requires a period of time to get it ready for its intended use.
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CA 12-2 (Continued)
The amount of interest cost for the first nine months of 2010 is the measure of the 2010 loss resulting from the tornado. The extension of the construction period to October 2010 because of the tornado does not warrant its capitalization as construction period interest. It is in effect an uninsured loss resulting from the tornado. Had it not been for the tornado, the entire amount would have been a normal operating expense chargeable against the rental revenue that would have been earned during the first nine months of 2010. Cost of obtaining tenants. Both the 2009 and 2010 costs of obtaining tenants should be expensed as incurred. The cost of obtaining tenants is a start-up cost. The accounting for start-up costs is straightforwardexpense these costs as incurred. The profession recognizes that these costs are incurred with the expectation that future revenues will occur or increased efficiencies will result. However, to determine the amount and timing of future benefits is so difficult that a conservative approachexpense these costs as incurredis required. Promotional advertising. The profession has concluded that, except in limited situations, future benefits from advertising are not sufficiently defined or measurable with a degree of reliability that is required to recognize these costs as an asset. As a result, the costs should be expensed as incurred or the first time the advertising takes place. The advertising costs incurred in 2010 might be reported as a loss to indicate that an unusual event caused this additional expense.
CA 12-3
(a) A dollar to be received in the future is worth less than a dollar received today because of an interest or discount factoroften referred to as the time value of money. The discounted value of the expected royalty receipts can be thought of either in terms of the present value of an annuity of 1 or in terms of the sum of several present values of 1. (b) If the royalty receipts are expected to occur at regular intervals and the amounts are to be fairly constant, their discounted value can be calculated by multiplying the value of one such receipt by the present value of an annuity of 1 for the number of periods the receipts are expected. On the other hand, if receipts are expected to be irregular in amount or if they are to occur at irregular intervals, each expected future receipt would have to be multiplied by the present value of 1 for the number of periods of delay expected. In each case some interest rate (discount factor) per period must be assumed and used. As an example, if receipts of $10,000 are expected each six months over the next ten years and an 8% annual interest rate is selected, the present value of the twenty $10,000 payments is equal to $10,000 times the present value of an annuity of 1 for 20 periods at 4%. Twice as many periods as years and half the annual interest rate of 8% are used because the payments are expected at semiannual intervals. Thus the discounted (present) value of these receipts is $135,903 ($10,000 X 13.5903). Because of the interest rate, this discounted value is considerably less than the total expected collection of $200,000. Continuing the example, if instead it is expected that $10,000 will be received six months hence, $20,000 one year from now, and a terminal payment of $15,000 is expected 18 months hence, the calculation is as follows: $10,000 X present value of 1 at 4% for 1 period = $10,000 X .96154 = $9,615. $20,000 X present value of 1 at 4% for 2 periods = $20,000 X .92456 = $18,491. $15,000 X present value of 1 at 4% for 3 periods = $15,000 X .88900 = $13,335. Adding the results of these three calculations yields a total of $41,441 (rounded), considerably less than the $45,000 total collections, again due to the discount factor.
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CA 12-3 (Continued)
(c) The basis of valuation for patents that is generally accepted in accounting is cost. Evidently the cartons were developed and the patents obtained directly by the client corporation. Those costs related to the research and development of the cartons must be expensed in accordance with GAAP. The costs of securing the patent should be capitalized. If the infringement suit is unsuccessful, an evaluation of the value of the patent should be made to ascertain the reasonableness of carrying forward the patent cost. If the suit is successful, the attorneys fees and other costs of protecting the patent should be capitalized and amortized over its remaining useful or legal life, whichever is shorter. (d) Intangible assets represent rights to future benefits. The ideal measure of the value of intangible assets is the discounted present value of their future benefits. For Ferry Company, this would include the discounted value of expected net receipts from royalties, as suggested by the financial vice-president, as well as the discounted value of the expected net receipts to be derived from Ferry Companys production. Other valuation bases that have been suggested are current cash equivalent or fair market value. (e) The amortization policy is implied in the definition of intangible assets as rights to future benefits. As the benefits are received by the firm, the cost or other value should be charged to expense or to inventory to provide a proper matching of revenues and expenses. Under the discounted value approach, the periodic amortization would be the decline during the year in the present value of expected net receipts. In practice, generally straight-line amortization is used because it is simple and provides a uniform amortization approach. Another approach would be the units-of-production method. (f) The litigation can and should be mentioned in notes to the financial statements. Some indication of the expectations of legal counsel in respect to the outcome can properly accompany the statements . It would be inappropriate to record a contingent asset reflecting the expected damages to be recovered. Costs incurred to September 30, 2010, in connection with the litigation should be carried forward and charged to expense (or to loss if the cases are lost) as royalties (or damages) are collected from the parties against whom the litigation has been instituted; however, the conventional treatment would be to charge these costs as ordinary legal expenses. If the final outcome of the litigation is successful, the costs of prosecuting it should be capitalized. Similarly, if the client were the successful defendant in an infringement suit on these patents, the generally accepted accounting practice would be to add the costs of the legal defense to the Patents account. Developments between the balance sheet date and the date that the financial statements are released would properly be reflected in notes to the statements as post-balance sheet (or subsequent events) disclosure.
CA 12-4
(a) Research, as defined in GAAP (FASB ASC 730-10-25), is planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service . . . or a new process or technique . . . or in bringing about a significant improvement to an existing product or process. Development, as defined in GAAP (FASB ASC 730-10-25), is the translation 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.
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CA 12-4 (Continued)
(b) The current accounting and reporting practices for research and development costs were promulgated by the Financial Accounting Standards Board (FASB) in order to reduce the number of alternatives that previously existed and to provide useful financial information about research and development costs. The FASB considered four alternative methods of accounting: (1) charge all costs to expense when incurred, (2) capitalize all costs when incurred, (3) selective capitalization, and (4) accumulate all costs in a special category until the existence of future benefits can be determined. The FASB concluded that all research and development costs should be charged to expense as incurred. (The authoritative guidance for R&D (FASB ASC 730-10-25) does not apply to activities that are unique to enterprises in the extractive industries. Accounting for the costs of research and development activities conducted for others under a contractual arrangement is a part of accounting for contracts in general and is addressed in other literature See FASB ASC 730-20-5.) In reaching this decision, the FASB considered the three pervasive principles of expense recognition: (1) associating cause and effect, (2) systematic and rational allocation, and (3) immediate recognition. The FASB found little or no evidence of a direct causal relationship between current research and development expenditures and subsequent future benefits. The FASB also stated that the high degree of uncertainty surrounding future benefits, if any, of individual research and development projects make it doubtful that there is any useful purpose to be served by capitalizing the costs and allocating them over future periods. In view of the above, the FASB concluded that the first two principles of expense recognition do not apply, but rather that the immediate recognition principle of expense recognition should apply. The high degree of uncertainty about whether research and development expenditures will provide any future benefits, the lack of objectivity in setting criteria, and the lack of usefulness of the resulting information led the FASB to reject the alternatives of capitalization, selective capitalization, and accumulation of costs in a special category. (c) The following costs attributable only to research and development should be expensed as incurred: Design and engineering studies. Prototype manufacturing costs. Administrative costs related solely to research and development. The cost of equipment produced solely for development of the product ($315,000). The remaining $585,000 of equipment should be capitalized and shown on the statement of financial position at cost, less accumulated depreciation. The depreciation expense resulting from the current year is a part of research and development expense for the year. The market research direct costs and related administrative expenses are not research and development costs. These costs are treated as period costs and are shown as expense items in the current income statement.
CA 12-5
(a) Investors and creditors are concerned with corporate profits, dividends, and cash flow. Employees in Czeslaw Corporations R&D department are concerned about job security if the company begins to hire outside firms rather than have work done internally. Reid must be concerned with his performance and reputation within the company as well. (b) Ethical issues include long-term versus short-term profits, concern for job security, loyalty to fellow employees, and an efficient operation. (c) Reid should do what is best for Czeslaw Corporation in the long run. He should choose to have the project done where the work will be done well and at the lowest cost. Whether expenses will appear in the income statement immediately or will be capitalized and allocated over a period of years should NOT be the driving factor in making the decision. He should be able to explain his decision to higherups and illustrate the different required accounting treatments. He also should give some thought to the impact on employee morale if he does not use the companys own R&D department.
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FINANCIAL REPORTING PROBLEM
(a) P&G reports Goodwill of $56,552 million for 2007. P&G also reports (net of amortization) Trademarks and other intangible assets of $33,626 million in 2007. P&G spent $2,112 million on research and development in 2007 and $2,075 million in 2006. In 2007, P&G spent 2.76% ($2,112/$76,476) of its sales on research and development costs. As a percent of net income, it spent 20.4% ($2,112/$10,340) of its net income on research and development. For 2006, the figures were 3.04% ($2,075/$68,222) of sales and 23.9% ($2,075/$8,684) of net income.
(b)
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COMPARATIVE ANALYSIS CASE
(a) (1) Coca-Cola reports: Trademarks, Goodwill and Other Intangible Assets . . . $12,219M. PepsiCo reports: Amortizable Intangible Assets (net) Goodwill and Other Non-Amortizable Intangible Assets of $7,213M. Coca-Cola: Intangible assets are 28.2% of total assets. PepsiCo: Intangible assets are 20.8% of total assets. At Coca-Cola, intangible assets increased $7,084M from $5,135M to $12,219M. At PepsiCo, intangibles increased $770M from $6,443M to $7,213M. Coca-Cola amortizes intangible assets that are deemed to have definite lives over their useful life primarily on a straight-line basis. PepsiCo amortizes amortizable intangible assets on a straightline basis over their estimated useful lives. Coca-Cola had accumulated amortization of $192M and $174M on December 31, 2007 and 2006, respectively. PepsiCo had accumulated amortization of $1,024M and $941M at year-end 2007 and 2006, respectively. Coca-Cola identified the composition of its intangible assets as follows: Trademarks with indefinite lives Goodwill Other intangible assets $ 5,153M 4,256 2,810 $12,219M
(2)
(3)
(b)
(1)
(2)
(3)
PepsiCo identified its intangible assets as follows: Amortizable intangible assets Goodwill Other nonamortizable intangible assets $ 796M 5,169 1,248 $7,213M
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FINANCIAL STATEMENT ANALYSIS CASE 1
MERCK AND JOHNSON & JOHNSON (a) The primary intangible assets of a healthcare products company would probably be patents, goodwill and trademarks. The nature of each of these is quite different; thus, an investor would normally want to know what the composition of intangible assets is if it is material. Many corporate executives complain that investors are too concerned about the short-term and dont reward good long-term planning. As a consequence, they feel that the requirement that research and development expenditures be expensed immediately penalizes those executives who do invest in the future. As a consequence, when net income does not look good, it is always tempting to cut research and development expenditures, since this will cause a direct increase in current year reported profits. Of course, it will also diminish the companys longterm prospects. If a company reports goodwill on its balance sheet, it can only have resulted from one thingthe company must have purchased another company. This is because companies are not allowed to record internally created goodwill. They can only report purchased goodwill. Ironically, if you want to report a large amount of goodwill, all you have to do is overpay when you purchase another companythe more you overpay, the more goodwill you will report. Obviously, reporting a lot of goodwill is not such a good thing.
(b)
(c)
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FINANCIAL STATEMENT ANALYSIS CASE 2
(a) The depressed market values (less than book value) suggest that market participants are not very optimistic about the future prospects for these companies. Accounting numbers are based in many cases on historical costs, while market prices will reflect new information about the company prospects. This situation does not look very promising. Because the market (fair) value of each company is less than its book value of its net assets, it fails the first step in the goodwill impairment test; an impairment should be recorded.
A B C D E F (Columns C D) Carryin g Value Marke t Company Sprint Nextel Washington Mutual E Trade Financial Value $36,3 61 11,74 2 1,639 4,104 2,035 23,941 Book Value (Net Assets) $51,271 of Goodw ill $30,71 8 9,062 RO A 3.5 % 2.4 % 5.6 % Total $26,007 2,069 0 2,035 14,879 0 9,062 Estimated Fair Value of Net Assets $20,553 Implied GW (NA-Market Value) $15,808 Goodwill Impairment $14,910 G (Columns B F) H (Columns D G)
(b)
(c)
As indicated in the expanded spreadsheet above, unless their market values increases dramatically, each of these companies is likely to recognize a goodwill impairment. For Washington Mutual and E-Trade, the impairment will result in a complete write-off of the goodwill asset. Apparently, the prior acquisitions from which the goodwill was recorded did not pan out for these companies. Loss on Impairment................................................ Goodwill.............................................................. 26,007 26,007
(d)
Impairment losses are reported in operating income. Thus, the impairments will reduce the numerator in the return on asset ratio. Without recognition of the impairments, these companies operating performance
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is overstated relative to companies in their cohort.
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INTERNATIONAL REPORTING CASE
(a) ROE = Net Income Stockholders Equity Bayer603 12,268 = 4.92% Glaxo Smithkline4,302 10,091 = 42.63% Merck5,813 17,288 = 33.6% Based on ROE, Glaxo-Smithkline exhibits the strongest profitability of these three companies at 42.6%. Bayer reports the lowest ROE at 4.9%. Examining the trend for each company and comparing it to other companies in the same country would also be useful in comparing these companies profitabilities. (b) Glaxo Smithkline indicates that goodwill may be amortized over a range of periodsup to 20 years. Goodwill amortization is not allowed under U.S. GAAP and IFRS. Thus, even if all companies use the maximum amortization period, it would be difficult to compare their amortization expenses and income measures. Unless U.K. companies adopt a no amortization policy, a lack of comparability exists. (c) Goodwill adjustments:
Bayer (DM millions) 0 603 603 0 12,268 12,268 4.92% 4.92% Glaxo Smithkline (Pounds millions) 12 4,302 4,314 84 10,091 10,175 42.6% 42.4% Merck ($ millions) 0 5,813 5,813 0 17,288 17,288 33.6% 33.6%
Related information (a) Amortization Expense (b) Net Income Adjusted Income (a + b) (c) Accumulated Goodwill Amortization (d) Stockholders Equity Adjusted SE (c + d) ROE (from ref. a) Adjusted ROE (a + b) (c + d)
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INTERNATIONAL REPORTING CASE (Continued) Making these adjustments results in a lower ROE for Glaxo Smithkline. This is due to the relatively large goodwill asset that has been written off by Glaxo. Bayers and Mercks ROE remains the same since they do not amortize goodwill per FASB and IFR Standards. Some analysts believe that goodwill should not be written off unless it is impaired. Per Statement of Financial Accounting Standards No. 141 and No. 142, goodwill is no longer amortized and is written off only if it is impaired. If written off, this understates assets and equity, resulting in an overstatement of profitability measures such as ROE and return on assets. This denominator effect can be more pronounced than the effects of amortization expense on income in the numerator of these ratios. (d) If some companies capitalize development expenses, this will result in higher reported assets and income (because R&D expense will be understated relative to U.S. GAAP). Thus any ratios relying on income and reported assets (ROA, ROE, Asset Turnover, etc.) should be adjusted for these effects. As long as the development costs and the development assets are disclosed, adjustments can be made to Bayers reports to make them comparable to Mercks, similar to the adjustments made in Part (c).
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PROFESSIONAL RESEARCH: FASB CODIFICATION
(a) FASB ASC 350-10-05 (Predecessor literature: Goodwill and Other Intangible Assets, Statement of Financial Accounting Standards No. 142 (Norwalk, Conn.: FASB, 2001)). Codification String: Assets > 350 Intangibles > Goodwill and other >10 Overall > 05 Background (b) Codification String: Assets > 350 Intangibles > Goodwill and other > 10 Overall > 20 Glossary Goodwill The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The amount recognized as goodwill includes acquired intangible assets that do not meet the criteria in Topic X805 for recognition as an asset apart from goodwill. [Prior literature: FAS 142, paragraph F1, sequence 639]] (c) Overall Accounting for Goodwill: Codification String; Assets > 350 Intangibles > Goodwill and other > 20 Goodwill > 35 Subsequent Measurement. Predessor literature in [Brackets]. 35-1 [Goodwill shall not be amortized. [FAS 142, paragraph 18, sequence 118.1]] [Instead, goodwill shall be tested for impairment at a level of reporting referred to as a reporting unit. [FAS 142 , paragraph 18, sequence 118.2.1.1]] [(Paragraphs 350-20-35-33 through 35-38 provide guidance on determining reporting units.) [FAS 142, paragraph 18, sequence 118.2.1.2]] [Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. [FAS 142, paragraph 18, sequence 118.2.2.1]] [The fair value of goodwill can be measured only as a residual and cannot be measured directly. Therefore, this Subtopic includes a methodology to determine an amount that achieves a reasonable estimated of the value of goodwill for purposes of measuring an impairment loss. That estimate is referred to as the implied fair value of goodwill. [FAS 142, paragraph 18, sequence 119]] [The two-step impairment test discussed in paragraphs 350-20-35-4 through 35-13 shall be used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). [FAS 142, paragraph 18, sequence 118.2.2.2]]
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35-3
> Recognition and Measurement of an Impairment Loss >> Step 1 35-4 [The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. [FAS 142, paragraph 19, sequence 120.1]] [The guidance in paragraphs 350-20-35-22 through 35-24 shall be considered in determining the fair value of a reporting unit. [FAS 142, paragraph 19, sequence 120.2.1]] [If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the impairment test is unnecessary. [FAS 142, paragraph 19, sequence 120.2.2.1]]
35-5 35-6
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FASB CODIFICATION (Continued)
35-7 [In determining the carrying amount of a reporting unit, deferred income taxes shall be included in the carrying value of the reporting unit, regardless of whether the fair value of the reporting unit will be determine assuming it would be bought or sold in a taxable or nontaxable transaction. [EITF 02-13, paragraph DISCUSSION, sequence 18]] [If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any [FAS 142, paragraph 19, sequence 120.2.2.2]]
35-8
(d) Codification String: Assets > 350 Intangibles > Goodwill and other > 20 Goodwill > 35 Subsequent Measurement 35-48 [All goodwill recognized by a public or nonpublic subsidiary (subsidiary goodwill) in its separate financial statements that are prepared in accordance with generally accepted accounting principles (GAAP) shall be accounted for in accordance with this Subtopic. Subsidiary g2 recognize a goodwill impairment. For Washington Mutual and E-Trade, the
impairment will result in a complete write-off of the goodwill asset. Apparently, the prior acquisitions from which the goodwill was recorded did not pan out for these companies. 26,007
Loss on Impairment................................................ Goodwill.............................................................. (d)
26,007
Impairment losses are reported in operating income. Thus, the impairments will reduce the numerator in the return on asset ratio. Without recognition of the impairments, these companies operating performance is overstated relative to companies in their cohort.
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INTERNATIONAL REPORTING CASE
(a) ROE = Net Income Stockholders Equity Bayer603 12,268 = 4.92% Glaxo Smithkline4,302 10,091 = 42.63% Merck5,813 17,288 = 33.6% Based on ROE, Glaxo-Smithkline exhibits the strongest profitability of these three companies at 42.6%. Bayer reports the lowest ROE at 4.9%. Examining the trend for each company and comparing it to other companies in the same country would also be useful in comparing these companies profitabilities. (b) Glaxo Smithkline indicates that goodwill may be amortized over a range of periodsup to 20 years. Goodwill amortization is not allowed under U.S. GAAP and IFRS. Thus, even if all companies use the maximum amortization period, it would be difficult to compare their amortization expenses and income measures. Unless U.K. companies adopt a no amortization policy, a lack of comparability exists. (c) Goodwill adjustments:
Bayer (DM millions) 0 603 603 0 12,268 12,268 4.92% 4.92% Glaxo Smithkline (Pounds millions) 12 4,302 4,314 84 10,091 10,175 42.6% 42.4% Merck ($ millions) 0 5,813 5,813 0 17,288 17,288 33.6% 33.6%
Related information (a) Amortization Expense (b) Net Income Adjusted Income (a + b) (c) Accumulated Goodwill Amortization (d) Stockholders Equity Adjusted SE (c + d) ROE (from ref. a) Adjusted ROE (a + b) (c + d)
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
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INTERNATIONAL REPORTING CASE (Continued) Making these adjustments results in a lower ROE for Glaxo Smithkline. This is due to the relatively large goodwill asset that has been written off by Glaxo. Bayers and Mercks ROE remains the same since they do not amortize goodwill per FASB and IFR Standards. Some analysts believe that goodwill should not be written off unless it is impaired. Per Statement of Financial Accounting Standards No. 141 and No. 142, goodwill is no longer amortized and is written off only if it is impaired. If written off, this understates assets and equity, resulting in an overstatement of profitability measures such as ROE and return on assets. This denominator effect can be more pronounced than the effects of amortization expense on income in the numerator of these ratios. (d) If some companies capitalize development expenses, this will result in higher reported assets and income (because R&D expense will be understated relative to U.S. GAAP). Thus any ratios relying on income and reported assets (ROA, ROE, Asset Turnover, etc.) should be adjusted for these effects. As long as the development costs and the development assets are disclosed, adjustments can be made to Bayers reports to make them comparable to Mercks, similar to the adjustments made in Part (c).
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROFESSIONAL RESEARCH: FASB CODIFICATION
(a) FASB ASC 350-10-05 (Predecessor literature: Goodwill and Other Intangible Assets, Statement of Financial Accounting Standards No. 142 (Norwalk, Conn.: FASB, 2001)). Codification String: Assets > 350 Intangibles > Goodwill and other >10 Overall > 05 Background (b) Codification String: Assets > 350 Intangibles > Goodwill and other > 10 Overall > 20 Glossary Goodwill The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The amount recognized as goodwill includes acquired intangible assets that do not meet the criteria in Topic X805 for recognition as an asset apart from goodwill. [Prior literature: FAS 142, paragraph F1, sequence 639]] (c) Overall Accounting for Goodwill: Codification String; Assets > 350 Intangibles > Goodwill and other > 20 Goodwill > 35 Subsequent Measurement. Predessor literature in [Brackets]. 35-1 [Goodwill shall not be amortized. [FAS 142, paragraph 18, sequence 118.1]] [Instead, goodwill shall be tested for impairment at a level of reporting referred to as a reporting unit. [FAS 142 , paragraph 18, sequence 118.2.1.1]] [(Paragraphs 350-20-35-33 through 35-38 provide guidance on determining reporting units.) [FAS 142, paragraph 18, sequence 118.2.1.2]] [Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. [FAS 142, paragraph 18, sequence 118.2.2.1]] [The fair value of goodwill can be measured only as a residual and cannot be measured directly. Therefore, this Subtopic includes a methodology to determine an amount that achieves a reasonable estimated of the value of goodwill for purposes of measuring an impairment loss. That estimate is referred to as the implied fair value of goodwill. [FAS 142, paragraph 18, sequence 119]] [The two-step impairment test discussed in paragraphs 350-20-35-4 through 35-13 shall be used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). [FAS 142, paragraph 18, sequence 118.2.2.2]]
35-2
35-3
> Recognition and Measurement of an Impairment Loss >> Step 1 35-4 [The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. [FAS 142, paragraph 19, sequence 120.1]] [The guidance in paragraphs 350-20-35-22 through 35-24 shall be considered in determining the fair value of a reporting unit. [FAS 142, paragraph 19, sequence 120.2.1]] [If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the impairment test is unnecessary. [FAS 142, paragraph 19, sequence 120.2.2.1]]
35-5 35-6
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
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FASB CODIFICATION (Continued)
35-7 [In determining the carrying amount of a reporting unit, deferred income taxes shall be included in the carrying value of the reporting unit, regardless of whether the fair value of the reporting unit will be determine assuming it would be bought or sold in a taxable or nontaxable transaction. [EITF 02-13, paragraph DISCUSSION, sequence 18]] [If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any [FAS 142, paragraph 19, sequence 120.2.2.2]]
35-8
(d) Codification String: Assets > 350 Intangibles > Goodwill and other > 20 Goodwill > 35 Subsequent Measurement 35-48 [All goodwill recognized by a public or nonpublic subsidiary (subsidiary goodwill) in its separate financial statements that are prepared in accordance with generally accepted accounting principles (GAAP) shall be accounted for in accordance with this Subtopic. Subsidiary goodwill shall be tested for impairment at the subsidiary level using the subsidiarys reporting units. If a goodwill impairment loss is recognized at the subsidiary level, goodwill of the reporting unit or units (at the higher consolidated level) in which the subsidiarys reporting unit with impaired goodwill resides must be tested for impairment if the event that gave rise to the loss at the subsidiary level would more likely than not reduce the fair value of the reporting unit (at the higher consolidated level) below its carrying amount (see paragraph 350-20-35-30(g)). Only if goodwill of that higher-level reporting unit is impaired would a goodwill impairment loss be recognized at the consolidated level. [FAS 142, paragraph 37, sequence 160]]
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROFESSIONAL SIMULATION
Journal Entries January 2, 2010 Patents................................................................ Cash.............................................................. July 1, 2010 Patents................................................................ Cash.............................................................. December 31, 2010 Patent Amortization Expense........................... Patents.......................................................... Computation of patent expense: $60,000 X 12/120 = $9,500 X 6/114 = Total Measurement Computation of impairment loss: Cost..................................................................... Less: Accumulated amortization.................... Book value.......................................................... *$36,000 X 18/96 = $6,750 $36,000 6,750* $29,250 $6,000 500 $6,500 60,000 60,000
9,500 9,500
6,500 6,500
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
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PROFESSIONAL SIMULATION (Continued) The book value of $29,250 is greater than net cash flows of $25,000. Therefore the franchise is impaired. The impairment loss is computed as follows: Book value.......................................................... Fair value............................................................ Loss on impairment........................................... Financial Statements Intangible assets as of December 31, 2009 Franchise............................................................ *Cost.................................................................... Less: Accumulated amortization.................... Total..................................................................... **$36,000 X 6/96 = $2,250 Note that the net loss and all organization costs are expensed in 2009. Intangible assets as of December 31, 2010: Franchise............................. $ 13,000 Patents................................. 63,000 ($60,000 + $9,500 $6,500) Goodwill............................... 180,000 Total intangible assets....... $256,000 Note that all the costs to develop the secret formula and the research and development costs are expensed as incurred. $33,750* $36,000 2,250** $33,750 $29,250 13,000 $16,250
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)