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NEW ERA UNIVERSITY

COLLEGE OF BUSINESS & ACCOUNTANCY
AUDITING PROBLEMS

AUDIT OF INTANGIBLE ASSETS AP 006
PROBLEMS RSPADERES
INSTRUCTION: ANSWER THE FOLLOWING QUESTIONS
PROBLEM 1
The following costs are generally incurred by a newly established entity:

Preoperating costs of a business facility 375,000
Purchased recipes and secret formula 225,000
Training, customer loyalty and market share 210,000
Licensing, royalty and standstill agreement 450,000
Operating and broadcast rights 168,000
Goodwill purchased in a business combination 750,000
A license to manufacture a steroid by means of a government grant 225,000
Cost of courses taken by management in quality engineering management 675,000
A television advertisement that will stimulate the sales in technology industry 150,000
Investment in associate 750,000
6 month lease payment in advance 450,000
Cost of equipment acquired through a finance lease 150,750
Internally developed customer list 180,750
Cost incurred in the corporations formation and organization 345,000
Operating losses incurred in the start up of the business 195,000
Initial franchise fees paid 262,500
Continuing franchise fees 75,000
Internally generated goodwill 1,200,000
Cost in testing in search for a product alternative 187,500
Cost of purchasing a patent from an inventor 205,500
Legal cost of securing a patent 105,000
Legal costs incurred in successfully defending a patent 83,250
Cost of developing brands, mastheads and publishing title 300,000
Cost of purchasing the trademark 375,000
Computer software from a computer-controlled machine that cannot
operate without that specific software 488,250
An operating system of a computer 187,500
Amount paid to a lessor for the exclusive right to rent a facility
under an operating lease agreement for a period of 10 years 150,000
Cost of improvements on a lease facility 375,000
REQUIRED: Compute for the total cost of intangible assets.
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PROBLEM 2
On January 2, 1011, David Inc,. acquired copyrights to the original recording of a famous singer.
The agreement with the singer allows the company to record and rerecord the songs of the singer
for a period of 5 years. During the initial 6-month period of the agreement, the singer was very sick
and consequently cannot record. The studio time that was blocked by the company had to be paid
even during the period the singer could not sing. The following costs were incurred by the
company:
Legal costs of acquiring the copy rights 15,000,000
Documentation expenses related to the copy acquisition 1,500,000
Operational costs (studio time lost etc.) 3,000,000
Massive advertising campaign to launch the artist 1,500,000

REQUIRED:
1) How much should the copy right be initially recognized?
2) What is the carrying value of the copy right as of December 31, 2011?


PROBLEM 3
Rodiel Inc. acquired the net assets of Ferrer Inc. on June 30, 2011 in a business combination. The
cost of the acquisition is P3,000,000 more than the total fair market value of the companys net
identifiable assets. Among the identifiable assets are the following intangibles:
Book value Fair value Estimated remaining life
Trademark 375,000 600,000 4
Customer list 750,000 1,125,000 3
Franchise 300,000 525,000 5
REQUIRED:
1) How much is the total intangibles including goodwill to be initially recognized?
2) What is the carrying value of the various intangibles including goodwill on December 31, 2011?

PROBLEM 4
On December 28, 2011, Joseph Corporation was granted by the government licenses to operate
radio and television stations over a 10-year period. The fair market value of the similar licenses is
at P2,250,000. The company paid professional and other processing fees totaling P75,000.

REQUIRED:
1) How much should the license be initially recognized?
2) What is the carrying value of the license on December 31, 2012?

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PROBLEM 5
On December 26, 2011, Zandra Co. obtained franchise from Donde Corp. to sell for 20 years Dondie
products. The initial franchise fee as agreed upon shall be P15,000,000 and shall be payable in
cash, P1,500,000 when the contract is signed and the balance in five equal installments every
December 31, thereafter, as evidenced by a noninterest bearing note. The agreement provides that
the franchisor shall provide the necessary initial services required under the franchise contract. By
the end of the year, the Company has performed all the initial services which costed Dondie
P2,246,592.

REQUIRED:
1) How much should the franchise be initially recorded?
2) What is the carrying value of the franchise on December 31, 2012?

PROBLEM 6
John Corp. is developing a new production process. During the year, total expenditure amounted to
P1,500,000nof which P1,350,000 was incurred before December 1, 2011 and P150,000 was
incurred between December 1 to December 31 of the same year. The entity was able to
demonstrate that at December 1, the production process met the criteria for recognition as an
intangible asset. The recoverable amount of the know-how embodied in the process (including cash
outflows to compute the process before it is available for use) is estimated to be P750,000.
During 2012, expenditure incurred is P3,000,000. At the end of 2012, the recoverable amount of
the know-how embodied in the process (including future cash outflows to compute the process
before it is available for use) is estimated to be P2,850,000.
REQUIRED:
1) How much should be the related intangible asset be initially recognized in 2011?
2) How much should be the intangible be recognized as of December 31, 2012?

PROBLEM 7
Llubel Inc. holds a vaiuable patent on a precipitator that prevents certain types of air pollution.
Llubel does not manufacture or sell the products and processes it develops. Instead, it conducts
research and develops products and processes which it patents, and then assigns patents to
manufacture on a royalty basis. Occasionally it sells patents. The following presents the summary
of the activities in relation to the aforementioned patent:
2003 Research aimed at the discovery of the new technology P5,760,000
01/05/2004 Design and construction of a prototype 1,314,000
03/15/2004 Testing the prototype model 630,000

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01/02/2005 Legal and other professional fees to process the
patent application (useful life = legal life) 930,000
12/10/2007 Legal fees paid to successfully defending the device patent 535,500
01/03/2009 Acquisition of the competitive patent aimed for protecting old
patent that shall increase company sales 609,000
01/05/2010 Acquisition of the related patent which extended the life of the
patent for additional 2 years 981,562
12/31/2012 Legal fees paid to unsuccessful patents infringement suit
against a competitor 375,000
REQUIRED
1) What is the correct cost of the patent upon initial recognition?
2) What is the carrying value of the patent on December 31, 2005?
3) What is the carrying value of the patent on December 31, 2009?
4) What is the carrying value of the patent on December 31, 2011?
5) What is the total cost from patent write off should be recognized in 2012?

PROBLEM 8
Madel Corporations patents had carrying value amounting to P840,000 as of December 31, 2012,
before amortization. All patents were purchased on January 2, 2004, 6 years after their
registration. Thus, these patents are being amortized over the remaining legal life from date of
purchase. Legal expenses in successfully defending the patent totaling to P112,500 were debited to
the account on January 2009. Amortization in 2009-2011 included amortization on the P112,500 for
the remaining life of the relevant patent. It is determined that the P112,500 should have been
expensed in 2009. It is further determined that one of the patents has a remaining life of only 3
years as at the beginning of 2012. This patent was originally assigned a cost of P315,000.
REQUIRED:
1) What is the correct amortization of 2012?
2) What is the adjusted carrying value of the patents as of December 31, 2012?
3) What is the retroactive adjustment to the beginning retained earnings, if there are any, as a
result of your audit?

PROBLEM 9
On April 1, 2012, Faye Corporation is contemplating to acquire all the issued and outstanding
ordinary shares of Mona Inc. in a business combination accounted for as a purchase. The recorded
assets and liabilities of Mona, Inc on April 1, 2012 follow:

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Cash P 800,000
Inventory 2,400,000
Property and equipment, net of accum depr or P3,200,000 3,500,000
Intangible assets, including P500,000 goodwill 1,300,000
Liabilities (1,800,000)
The fair market value of the assets and liabilities of Mona Inc. on April 1, 2012 are as follows:
Cash P 800,000
Inventory 2,400,000
Property and equipment, net of accum depr or P3,200,000 4,100,000
Intangible assets, including P500,000 goodwill 1,000,000
Liabilities (1,800,000)
Records show that the company earned an accumulated net income of P4,650,000 from 2007-2011.
The said accumulated profits included a gain on sale of fixed assets in 2010 and 2011 totaling to
P1,000,000 and presidents annual bonus averaging to P150,000.
Remaining life at the date of acquisition of PPE is 6 years and intangible assets have indefinite lives.
The industrys normal rate of return is 9%.
REQUIRED:
1) Assuming that the company contemplates the acquisition price at P8,000,000, how much is the
goodwill resulting from the resulting combination?
2) How much is the resulting goodwill and the assumed acquisition price if goodwill is computed
using the purchase of excess earnings method over a 10-year period?
3) How much is the resulting goodwill and the assumed acquisition price if the excess earnings will
be capitalized at 12%?
4) How much is the resulting goodwill and the assumed acquisition price if the average earnings will
be capitalized at 10%?
5) How much is the resulting goodwill and the assumed acquisition price if the present value
method is in place and that the prevailing rate of interest is at 10% over the 10-year period excess
earnings is expected to be generated?

PROBLEM 10
On January 1, 2011, ABC Corporation acquired DEF Incs, net assets for a total of P10,000,000.
DEF Inc. has manufacturing plants in three countries. The fair market values of the identifiable net
assets of the operations from each country were as follows:
Country X P2,000,000
Country Y 1,500,000
Country Z 4,500,000
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At the beginning of 2012, a new government is elected in Country Z. It has promulgated a new
legislation significantly restricting exports of ABC Corporations, main product. As a result, and for
the forseeable future, ABC Corporations production in Country Z will be cut by 40%. On the same
date, the carrying values of Country Zs net assets were as follows:
Cash P 700,000
Receivables 1,800,000
Inventories 1,500,000
Property and equipment0 net 2,700,000
Goodwill ?
Payables 700,000
Moreover, the company originally estimated annual future net cash flows from its operations in
Country Z at P1,500,000.
ABC uses the straight line method of depreciation over a 10-year life for the Country Z identifiable
assets and anticipates no residual value. It is also estimated that the prevailing market rate of
interest that reflects current market assessments of the time value of money and the risks specific
to Country Z cash-generating unit was 15%.
REQUIRED:
1) How much is goodwill allocated to the cash generating unit Country Z upon acquisition?
2) How much is the value in use of cash generating unit Coutnry Z as of January 1, 2012?
3) How much from the total impairment loss should be recognized against goodwill of the cash-
generating unit Country Z?
4) What is the carrying value of the cash generating unit Company Zs property and equipment after
impairment loss recognition?
5) Assuming that inventories had fair value less cost to sell of P1,500,000, what is the carrying
value of the property and equipment after impairment loss recognition?

PROBLEM 11
Vergile Corp. maintains the following items in its intangible account as of fiscal year ended June 30,
2012:

Research (RED MICAH) P98,475
Copyrights 94,500
Goodwill 48,000

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Audit findings:
a) Research RED MICAH is for a research project which consists of the following charges:

Salaries of research staff P27,750
Patent acquired solely for the use of the project 18,000
Special equipment acquired and useful for various
similar research activities 15,000
Patent acquired for use in several research projects
including project (RED MICAH) 24,300
Cost of pilot models 13,425
Total P98,475

The patent has generally been found to be useful for approximately ten years while the
special equipment useful for five years. You have further discovered both pantents and the
specialized equipment were acquired at the beginning of the fiscal year and that cost of
models and salaries were incurred evenly throughout the fiscal year. Amortization is yet to
be made on the related intangible.
b) The Companys copyright were accounted for as follows:

ASSET ACQUISITION DATE USEFUL LIFE COST
Copyright R23 January 2, 2008 25 years P45,000
Copyright B42 July 15, 2009 15 years 49,500

You have discovered that the company made no amortizations on the above intangibles from
the year of acquisition.
c) The Companys goodwill was acquired as part of business combination when it acquired the
net assets of JM Corp. at an acquisition cost amounting to P2,373,000 on February 24, 2010.
JMs net assets were carried in its book at P2,325,000 while their fair value aggregated to
P2,340,000.

d) Management has now decided to correct its past accounting treatment deciding to use the
straight-line method of amortizing intangibles computed to the nearest half-year.

REQUIRED:
1) What is the carrying value as of June 30, 2012 of Project RED Micah, Patent, Copyrights and
Goodwill
2) How much should be recognized as research expense for the fiscal year 2012?
3) How much is the amortization expense for the copyrights in fiscal year 2012?
4) How much is the amortization expense for the goodwill in fiscal year 2012?

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PROBLEM 12
Edward Corporation is engaged in developing computer software for small business at home
computer market. Most of the computer programmers are involved in developmental work
designed to produce software that will perform fairly specific tasks in a user-friendly manner.
Extensive testing of the working model is performed before it is released to production for
preparation of masters and further testing. As a result of careful preparation, Edward Corp, has
produced several products that have been very successful in the market place. The following costs
were incurred during 2012:
Salaries and wages of programmers during research P660,000
Expenses related to projects prior to establishments of technological feasibility 470.400
Cost of completing the detailed program design 750,000
Cost of coding the product master after technical feasibility has been established 141,000
Cost of testing the product master after technical feasibility has been established 156,000
Amortization of capitalized software development cost from current and prior years 160,500
Cost to produce and prepare software for sale 337,800
Additional data for 2012:
Sale of products for the year P3,090,000
Beginning inventory 852,000
Portion of goods available for sale sold during the year 60%
REQUIRED:
1) What is the amount to be capitalized software development cost subject to amortization?
2) What is the cost of the ending inventory?
3) What is the total amount related to the development of computer software that should be
expensed when incurred?

PROBLEM 13
Howard Corporation acquired a patent right on July 1, 2007 for P250,000. The remaining legal life
on the date of purchase is 15 years. However, due to rapidly changing technology, management
estimates that the remaining useful life on July 1, 2007 is only 5 years.
At January 1, 2008, management is uncertain that the process can actually be made economically
feasible and decides to write down the patent to and estimated recoverable amount of P75,000.
Amortization will be taken over 3 years from the point.
On January 1, 2010, having perfected the related production process, the entity adopts the
revaluation mode to measure the patent. He patent now has a fair value of P300,000.
Furthermore, the estimated remaining useful life is now believed to be 5 years.
REQUIRED:
1) How much is the loss on impairment on January 1, 2008?
2) How much can be recognized as gain on impairment recovery in 2010?
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3) How much is the revaluation surplus as of January 1, 2010?
4) How much is the carrying amount of the patent on December 31, 2010?

PROBLEM 14
Elisa Corporation has its own research department. However, the Company purchases patents from
time to time. The following is a summary of transactions involving patents now owned by the
company:
- During 2006 and 2007, Elisa spent a total of P459,00 in developing a new process that was
patented (Patent X) on April 1, 2008; additional legal and other costs of P50,000 were incurred.
- A patent (Patent Y) developed by Husein Dee, an inventory was purchased for P187,500 on
December 1, 2009 on which date it had an estimated useful life of 12 and 1/2 years.
- During 2008, 2009 and 2010, research and development activities cost P510,000. No additional
patents resulted from these activities.
- A patent infringement suit brought by the Company against a competitor because of the
manufacture of articles infringing on Patent Y was successfully prosecuted at Acost of P42,600. A
decision in the case was rendered in June 2010.
- On June 1, 2011, Patent Z was purchased for P172,800. This patent had 16 years yet to run.
- During 2012, Elisa expended P180,000 on patent development. However, the Company is still
undecided as to how the patent, if approved by the Bureau of Patents, will generate probable future
economic benefits.
REQUIRED:
1) What is Patent Xs carrying value on December 31, 2012?
2) What is Patent Ys carrying value on December 31, 2012?
3) What is Patent Zs carrying value on December 31, 2012?
4) What is the total patent amortization expense to be reported on Elisas statement of
comprehensive income for the year ended December 31, 2012?
]
PROBLEM 15
ABC Corp., a computer software development and software distribution company, presented the
following items among its noncurrent assets in its Statements of Financial Position as of December
31, 2010:
Franchise P10,000,000
Computer software 4,050,000
Goodwill 2,100,000
Your audit of the said items revealed the following information:
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a. The franchise agreement was between ABC and DEF Inc. which granted ABC the exclusive
right to distribute the computer software products of DEF Inc. in certain areas of eastern
and central Visayas for an indefinite period. The agreement was entered into early in
January of 2007 and has required ABC corporation to pay DEF Inc. the total franchise fee
amounting to P10M. 40% of the amount has been paid outright as down payment with the
remaining balance payable in 5 equal installments starting the year after the agreement was
completed. The prevailing market rate of interest for this type of transaction by the time the
agreement was entered into was 11%. The company recorded the transaction as follows:

01/01/07 Franchise 10M
Cash 4M
Notes payable 6M

The Company charged the notes payable thereafter for the subsequent periodic payments.

During the current year, verifiable evidence show that future net cash flows expected from
franchise agreement with DEF may have been affected by the launching of DEFs competitor
for equally competitive products in the eastern and central visayas market. The company
now estimates that its average net annual cash flows from distributing products of DEF
amounting to P1.8M annually and will be cut by 40% because of this development. You
have ascertained that the appropriate discount rate useful in the measuring impairment loss
on the franchise is at 15%.

b. The Company started developing computer software for small and medium business
enterprises on January 1, 2009. The computer software account therefore, refers to the
cost of computer application software developed internally by the company and distributes
to small and medium business enterprises in eastern and central visayas. The carrying value
of the software comprise of the following:

Cost incurred in the research activities relating to the
creation of computer software P750,000
Costs incurred in completing the detailed program design 500,000
Cost of computer facilities especially acquired for the coding and testing
of product masters of the computer software (useful for many software
development projects over 3 years) 700,000
Operating system of the computer facility above 200,000
Salaries of staff who worked on the coding and testing of the product masters 1,100,000
Cost of supplicating the product master for sale 800,000

The Company was able to complete its first computer software for distribution by the end of
2009 and was able to sell the first batch of the products in 2010 generating P3M in product
sales. The company estimates that the computer software shall be salable for about two
more years at which time a better and more superior computer software with same
capability may have been already created. The company further projects that it will
generate approximately P1.5M more in product sale in 2011 and P500,000 in 2012.
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c. The Companys Goodwill account comprise of the following expenditures:

Preoperating expenses incurred in 2006 P400,000
Massive advertising costs incurred in the early 2006 and 2007 to
enhance the companys image in the market (this increased potential
for the company to generate sales in the future) 1,200,000
Cost of building rapport and customer loyalty leading to very loyal customers
who are committed to availing services of the company for an indefinite
period of time 500,000
Total P2,100,000

REQUIRED:
1) What is the correct carrying value of the Franchise as of December 31, 2010, before any
impairment lsos, if there are any, is recognized?
2) What is the retroactive adjustment to the retained earnings, beginning as a result of your audit
of the companys franchise?
3) What is the impairment loss to be recognized against the franchise fee for the year ended
December 31, 2010?
4) What is the adjustment to the retained earnings, beginning as a result of your audit of the
companys computer software?
5) What is the carrying value of the computer software account as of December 31, 2010?
6) How much from the items included as part of the companys Goodwill can be recognized
separately as intangible asset?