12
Intangible CHAPTER Assets
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 intangible-asset 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.
*This material is covered in an Appendix to the chapter.
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CHAPTER REVIEW
*Note: All asterisked (*) items relate to material contained in the Appendix to the chapter.
1. Chapter 12 discusses the basic conceptual and reporting issues related to intangible assets.
Valuing and Amortizing Intangibles
2. (L.O. 1)The characteristics of intangible assets are: (1) they lack physical existence, and
(2) they are not a financial instrument. The most common types of intangibles reported are
patents, copyrights, franchises, licenses, trademarks, trade names, and goodwill.
3. (L.O. 2)Cost is the appropriate basis for recording purchased intangible assets. Like
tangible assets, cost includes acquisition price and all other expenditures necessary in
making the asset ready for its intended usefor example, purchase price, legal fees, and
other incidental expenses. When intangibles are acquired for stock or other assets, the
cost of the intangible is the fair value of the consideration given or the fair value of the
intangible received, whichever is more clearly evident. Costs incurred to create
internally-created intangibles are generally expensed as incurred.
Amortization of Intangibles
4. (L.O. 3)Intangibles have either a limited (finite) useful life or an indefinite useful life. An
intangible asset with a limited life is amortized; an intangible asset with an indefinite life is
not amortized.
Limited-Life Intangibles
5. The expiration of intangible assets is called amortization. Limited-life intangibles should
be amortized by systematic charges to expense over their useful life. The useful life
should reflect the periods over which these assets will contribute to cash flows.
6. The amount of amortization expense for a limited-life intangible asset should reflect the
pattern in which the asset is consumed or used up, if that pattern can be readily
determined. If not, the straight-line method of amortization should be used. When intangible
assets are amortized the charges should be shown as expenses, and the credits should
be made either to the appropriate asset accounts or to separate accumulated amortization
accounts. The amount of an intangible asset to be amortized should be its cost less
residual value.
Indefinite-Life Intangibles
7. If no legal, regulatory, contractual, competitive, or other factors limit the useful life of an
intangible asset, the useful life is considered indefinite. An intangible with an indefinite
life is not amortized, instead it is tested for impairment.
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Marketing-Related Intangible Assets
8. (L.O. 4)Marketing-related intangible assets are those assets primarily used in the
marketing or promotion of products or services. Examples are trademarks or trade names ,
newspaper masthead, Internet domain names, and noncompetition agreements.
9. A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies
a particular company or product. The right to use a trademark or trade name, whether it is
registered or not, rests exclusively with the original user as long as the original user
continues to use it. Registration with the U.S. Patent and Trademark Office provides legal
protection for an indefinite number of renewals for a period of 10 years each. When the
total cost of a trademark or trade name is insignificant, it can be expensed rather than
capitalized. In most cases, the life of a trademark or trade name is indefinite, and therefore
its cost is not amortized.
Customer-Related Intangible Assets
10. Customer-related intangible assets occur as a result of interactions with outside parties.
Examples are customer lists, order or production backlogs, and both contractual and
noncontractual customer relationships.
Artistic-Related Intangible Assets
11. Artistic-related intangible assets involve ownership rights to plays, literary works,
musical works, pictures, photographs, and video and audiovisual material. These ownership
rights are protected by copyrights. A copyright is a federally granted right that all authors ,
painters, musicians, sculptors, and other artists have in their creations and expressions.
A copyright is granted for the life of the creator plus 70 years. It gives the owner, or heirs,
the exclusive right to reproduce and sell an artistic or published work. Copyrights are not
renewable. Generally, the useful life of the copyright is less than its legal life (life of the
creator plus 70 years). The costs of the copyright should be allocated to the years in
which the benefits are expected to be received.
Contract-Related Intangible Assets
12. Contract-related intangible assets represent the value of rights that arise from contractual
arrangements. Examples are franchise and licensing agreements, construction permits,
broadcast rights, and service or supply contracts. A franchise is a contractual arrangement
under which the franchisor grants the franchisee the right to sell certain products or
services, to use certain trademarks or trade names, or to perform certain functions, usually
within a designated geographical area. A license or permit is the arrangement commonly
entered into by a governmental body and a business enterprise that uses public property.
Franchises and licenses can have limited or indefinite lives. The cost of a franchise (or
license) with a limited life should be amortized as operating expense over the life of the
franchise; whereas those with an indefinite life should be carried at cost and not amortized.
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Technology-Related Intangible Assets
13. Technology-related intangible assets relate to innovations or technological advances.
Examples are patented technology and trade secrets. A patent gives the holder exclusive
right to use, manufacture, and sell a product or a process for a period of 20 years without
interference or infringement by others. If a patent is purchased from an inventor (or other
owner), the purchase price represents its cost. Research and development costs related
to the development of the product, process, or idea that is subsequently patented must be
expensed as incurred. The costs of the patent should be amortized over its legal life or its
useful life, whichever is shorter.
Goodwill
14. (L.O. 5 and 6)In a business combination, the cost (purchase price) is assigned where
possible to the identifiable tangible and intangible net assets, and the remainder is recorded
in an intangible asset account called goodwill. Goodwill generated internally should not
be capitalized in the accounts is recorded only when an entire business is purchased.
it
To record goodwill, the fair value of the net tangible and identifiable intangible assets are
compared with the purchase price of the acquired business. The difference is goodwill.
Goodwill is considered to have an indefinite life and therefore should not be amortized. A
bargain purchase results when the fair value of the net assets acquired is higher than the
purchase price of the assets. The FASB requires that the excess be recognized as a gain
and that the nature of the gain be disclosed.
Impairments
15. (L.O. 7)When the carrying amount of a long-lived asset (property, plant, and equipment
or intangible assets) is not recoverable, a write-off of the impairment is needed. To determine
if property, plant, or equipment has been impaired, a recoverability test is used. The first
step of the test, an estimate of the future net cash flows expected from the use of that
asset and its eventual disposition are determined. If the sum of the expected future net
cash flows (undiscounted) is less than the carrying amount of the asset, an impairment
has occurred. If an impairment loss has been incurred, it is the amount by which the
carrying amount of the asset exceeds its fair value. The impairment loss is reported as
part of income from continuing operations, generally in the Other expenses and losses
section.
16. The rules that apply to impairments of property, plant, and equipment also apply to
limited-life intangibles. Indefinite-life intangibles other than goodwill should be tested for
impairment at least annually using the fair value test. This test compares the fair value of
the intangible asset with the assets carrying amount. If the fair value of the intangible
asset is less than the carrying amount, impairment is recognized.
17. The impairment rule for goodwill is a two-step process. First, the fair value of the reporting
unit should be compared to its carrying amount including goodwill. If the fair value of unit the
reporting is greater than the carrying amount, goodwill is considered not to be
impaired, and the company does not have to do anything. However, if the fair value is
less than the carrying amount of the net assets, then the second step compares the fair
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value of the goodwill to its carrying amount and the impairment is the difference between
the carrying amount and the fair value.
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18. Once an impairment loss is recorded, the reduced carrying amount of an asset held for
use becomes its new cost basis
and is not changed except for depreciation or
amortization in future periods or for additional impairments.
19. Even if the fair value of an impaired asset increases, a company may not recognize
restoration of the previously recognized impairment loss.
Research and Development Costs
20. (L.O. 8)Planned research or critical investigation aimed at discovery of new knowledge
are research activities. 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 are development activities. In
general, all research and development costs are to be charged to expense when incurred.
21. (L.O. 9)The costs associated with R&D activities and the accounting treatment accorded
them are as follows:
a. Materials, Equipment, and Facilities.Expense the entire costs, unless the items have
alternative future uses (in other R&D projects or otherwise), in which case carry as
inventory and allocate as consumed; or capitalize and depreciate as used.
b. Personnel.Salaries, wages, and other related costs of personnel engaged in R&D
should be expensed as incurred.
c. Purchased Intangibles.Recognize and measure at fair value. After initial recogni tion, account for in accordance with their nature (either limited-life or indefinite-life
intangibles).
d. Contract Services.The costs of services performed by others in connection with the
reporting companys R&D should be expensed as incurred.
e. Indirect Costs.A reasonable allocation of indirect costs shall be included in R&D
costs, except for general and administrative cost, which must be clearly related in
order to be included and expensed.
22. Start-up costs, initial operating costs, and advertising costs are also expensed as
incurred.
Presentation of Intangibles and Related Items
23. (L.O. 10)On the balance sheet, all intangible assets other than goodwill should be reported
as a separate item. If goodwill is present, it also should be reported as a separate item.
On the income statement, amortization expense and impairment losses for intangible assets
other than goodwill should be presented as part of continuing operations. Goodwill
impairment losses should also be presented as a separate line item in the continuing
operations section, unless the goodwill impairment is associated with a discontinued
operation.
24. Companies should disclose, generally in the notes, the total R&D cost charged to
expense during each period for which they present an income statement.
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Accounting for Computer Software Costs
*25. (L.O. 11)Costs incurred in creating a computer software product that is to be sold, leased ,
or otherwise marketed to third parties should be charged to research and development
expense when incurred until technological feasibility has been established for the product.
Technological feasibility is established upon completion of a detailed program design or
working model.
*26. If software is purchased and it has alternative future uses, then it may be capitalized.
*27. When software costs are capitalized companies are required to use the greater of (1) the
ratio of current revenues to current and anticipated revenues (percent-of-revenue
approach), or (2) the straight-line method over the remaining useful life of the asset
(straight-line approach) as a basis for amortization.
*28. Capitalized software costs should be valued at the lower of unamortized cost or net
realizable value. If net realizable value is lower, then the capitalized software costs should
be written down to this value. Once written down, they may not be written back up.
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*IFRS Insights
There are some significant differences between IFRS and GAAP in the accounting for both
intangible assets and impairments. IFRS related to intangible assets is presented in IAS 38
(Intangible Assets). IFRS related to impairments is found in IAS 36 (Impairment of Assets).
RELEVANT FACTS
Like GAAP, under IFRS intangible assets (1) lack physical substance and (2) are not
financial instruments. In addition, under IFRS an intangible asset is identifiable. To be
identifiable, an intangible asset must either be separable from the company (can be sold or
transferred) or it arises from a contractual or legal right from which economic benefits will
flow to the company. Fair value is used as the measurement basis for intangible assets
under IFRS, if it is more clearly evident.
As in GAAP, under IFRS the costs associated with research and development are
segregated into the two components. Costs in the research phase are always expensed
under both IFRS and GAAP. Under IFRS, however, costs in the development phase are
capitalized once technological feasibility (referred to as economic viability) is achieved.
IFRS permits revaluation on limited-life intangible assets. Revaluations are not
permitted for goodwill and other indefinite-life intangible assets.
IFRS 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. GAAP requires expensing of all costs associated with internally generated
intangibles.
IFRS 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 assets, discounted to present value. Under GAAP, impairment loss is
measured as the excess of the carrying amount over the assets fair value.
IFRS allows reversal of impairment losses when there has been a change in economic
conditions or in the expected use of limited-life intangibles. Under 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. IFRS and GAAP are similar in the accounting for impairments
of assets held for disposal.
With issuance of a recent converged statement on business combinations ( IFRS 3 and
SFAS No. 141Revised), IFRS and GAAP are very similar for intangibles acquired in a
business combination. That is, companies recognize an intangible asset separately from
goodwill if the intangible represents contractual or legal rights or is capable of being
separated or divided and sold, transferred, licensed, rented, or exchanged. In addition,
under both GAAP and IFRS, companies recognize acquired in-process research and
development (IPR&D) as a separate intangible asset if it meets the definition of an
intangible asset and its fair value can be measured reliably.
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ILLUSTRATION 12-1
ACCOUNTING TREATMENT OF INTANGIBLES
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ILLUSTRATION 12-2
TYPES OF INTANGIBLE ASSETS
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ILLUSTRATION 12-3
RECORDING GOODWILL
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ILLUSTRATION 12-3 (continued)
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ILLUSTRATION 12-4
ACCOUNTING FOR IMPAIRMENT OF LIMITED-LIFE INTANGIBLES
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ILLUSTRATION 12-5
CALCULATING AND RECORDING IMPAIRMENT LOSS
FOR PATENTS
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ILLUSTRATION 12-6
IMPAIRMENT OF INDEFINITE-LIFE INTANGIBLESOTHER
THAN GOODWILL
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ILLUSTRATION 12-7
IMPAIRMENT OF GOODWILL
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ILLUSTRATION 12-8
RESEARCH AND DEVELOPMENT COSTS
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