Intermediate

Financial Accounting I

Intangible Assets
Chapter Outline
 Definition and common types of
intangible assets
 Valuation and costs of intangibles
 Accounting for finite-life intangibles
and intangibles with indefinite lives.
 Accounting for patents, copyrights,
franchise and licenses, trade names
and trademarks, and start-up costs.
 Accounting for R&D and computer
software costs.
 Accounting for goodwill
Intangible Assets 2
Definition Of Intangible Assets
Assets --

a. with future economic benefits,

b. no physical substance,

c. with high degree of uncertainty

concerning the future benefit.

Intangible Assets 3
Common Types of Intangibles

 Patents, copyrights, franchises,

start-up costs, trade names,
trademarks, goodwill etc..

Intangible Assets 4
Valuation of Intangibles
 Intangibles are recorded at cost and
are also reported at cost at the end of
an accounting period.
 Intangibles with limited life are subject
to amortization and possible
impairment test.
 Intangibles with indefinite life are only
subject to impairment test at least
annually.
Intangible Assets 5
Costs of Intangibles
 Costs of Intangibles include acquisition
costs plus any other expenditures
necessary to make the intangibles ready
for the intended uses (i.e., purchase price,
legal fees, filing fees etc.; not including
internal R&D).

 Essentially, the accounting treatment of

valuation for intangibles closely parallels
that followed by tangible assets.
Intangible Assets 6
Examples

1. Issuance of stock to acquire intangibles.

2. Lump-sum purchase of intangibles.

 Costs will be allocated in accordance
with the fair market value of each
individual intangible.

Intangible Assets 7
Intangibles Assets with Finite lives
 Patents (20 years), copyrights (the life
of the creator plus 70 years), franchise
and license (the contractual life).
 The costs are subjected to amortization
(a process of cost allocation) over the
shorter of the legal or useful life, not to
exceed 40 years.

Intangible Assets 8
Amortization of Intangibles
 The impairment test needed only when
events indicate that the book value may
not be recoverable.
 Amortization Method: Straight-line
method.
 Other method can be applied if it is more
appropriate than the S-L method.
 Residual value: Usually zero.
Intangible Assets 9
Amortization of Intangibles (contd.)
 Journal Entry:

Amortization Expense xxx

Intangible Asset xxx
(or Accumulated Amortization)

Intangible Assets 10
Intangibles Assets with Indefinite
Lives
 Trade names, trademarks, goodwill, in-
process R&D.
 The costs are not subject to
amortization.
 Impairment test is required at least
annually.

Intangible Assets 11
1. Patents
 Granted by the U.S. Patent and
Trademark Office for a period of 20
years.
 A patent gives the holder the exclusive
right to produce, use and sell a product
or process without interference or
infringement from others.

Intangible Assets 12
Patents (contd.)
 Cost of patent: If purchased from an
inventor, the cost will include the
purchase price plus any legal fees (to
successfully protect the patent).
 In addition, any legal fees occur after the
acquisition of a patent which
successfully defend the right of the
patent should also be capitalized.

Intangible Assets 13
 Patents (contd.)
 The cost of a patent should be
amortized over the legal life or the useful
life, whichever is shorter.

Intangible Assets 14
Patents (contd.)
Journal Entry

Amortization Expense xxx

Patents
(or Accu. Patent Amortization) xxx

Using straight-line method (partial year should be

applied)

Intangible Assets 15
Patents (contd.)
 If events indicate the book value of a patent
may not be recoverable, an impairment test
is required (see Chapter 11 for details)
 If a patent becomes worthless, the net
value of the patent should be written off as
loss.
 If a patent is internally developed, no cost
can be capitalized.
 Most of the research and development
(R&D) costs are expensed.
Intangible Assets 16
2. Copyrights
 A federally granted right to authors,
sculptors, painters, and other artists for
their creations.
 A copyright is granted for the life of the
creator plus 70 years.
 It gives the creator and heirs an
exclusive right to reproduce and sell
the artistic work or published work.
Intangible Assets 17
Copyrights (contd.)
 If purchased, the cost includes the
purchase price plus any legal fees.
 If developed by the owner (the
creator), no cost can be capitalized.
 Amortization: Straight-line method or a
unit-of-production method.
 Impairment test needed only if events
indicate that book value may not be
recoverable. Intangible Assets 18
3. Franchise & License
 A franchise is a contractual agreement
under which the franchiser grants the
franchisee the right to sell certain
products or service or to use certain
trade names or trademarks.
 A license is a contractual agreement
between a governmental body (i.e., city,
state, etc.) and a private enterprise to
use public property to provide services.
Intangible Assets 19
Franchise & License (contd.)
 Costs: Franchise fees plus any legal
fees should be capitalized.
 Amortization: over the shorter of the
contractual life or the useful life, not to
exceed 40 years.
 Impairment test is needed only if events
indicate that the book value may not be
recoverable.
Intangible Assets 20
4. Trademarks & Trade Names
 A word, a phrase, or a symbol that
distinguishes a product or an enterprise
from another (i.e., company names,
XEROX,…)
 Cost: Similar to that of copyrights.

Intangible Assets 21
Trademarks & Trade Names
 Life: register at the US Patent Office for
10 years life. The registration can be
renewed every 10 years for unlimited
times.
 Amortization: no amortization necessary.
 Impairment test is required at least
annually.

Intangible Assets 22
5. Start-Up Costs (including Organization
Costs)
 Start-up costs: Any costs incurred for the
preparation of introducing a new product
or new service or start business in a new
territory.
 Org. Costs: Costs associated with the
formation of a corporation including fees
to underwriters (for stock issuance), legal
fees, promotional expenditures, etc.
 These costs should be expensed as
incurred. Intangible Assets 23
6. Research and Development (R&D)
 Prior to SFAS 2 (effective in 1974), the
practice was to either expense or
capitalize R&D related expenditures.
 SFAS 2 requires to expense and
disclose all R&D costs if the results of
R&D are for internal use.

Intangible Assets 24
6. Research and Development
(R&D)
 R&D costs include salaries of personnel
involved in R&D, costs of materials used,
equipments, facilities and intangibles used
in R&D activities.
 If equipment has an alternative usage,
the equip. should be capitalized and only
the depreciation expense will be included
in the R&D expense.

Intangible Assets 25
R&D: An Example
Cash expenditures related to the R&D are as
follows:
R&D salaries and wages $100,000
R&D material &supplies used 50,000
R&D equip. purchased* 120,000
Payments to others for service
performed related to R&D 30,000
Patent filing and legal fees
for completed project 25,000

Intangible Assets 26
R&D: An Example (contd.)
 *The equipment purchased will be used in
other projects and the depreciation on the
equipment in 2008 was $ 10,000.
 R&D expenses include the followings:
 R&D salary: $100,000; R&D
material:$50,000; depre. Expense: $10,000;
payments to others: $30,000 .
 The following expenditures are capitalized:
 Equipment: $120,000 ; Patent: $25,000.
Intangible Assets 27
R & D Contracts
 Costs of R&D performed under
contracts for others are capitalized as
inventory or receivable.
 Income from these contracts can be
recognized based on percentage-of
completion or complete contract
method as discussed for the long-term
construction contracts.
Intangible Assets 28
Purchased R&D
 When acquiring another company, the
purchase price is allocated to tangible
assets, intangibles (developed
technology) and in-process R&D.
 The remaining will be the goodwill.
 The in-process R&D is expensed prior
to 2009.

Intangible Assets 29
Purchased R&D (Contd.)
 The fair value of in-process R&D is
capitalized as indefinite-life intangible
asset for business acquisition made in
fiscal years beginning on or after
12/15/2008 (SFAS 141 (revised)).
 The capitalized in-process R&D should
not be amortized but is subject to
impairment test.
Intangible Assets 30
International Financial Reporting
Standards – R&D (IAS 38)
 Research expenditures are expenses
as incurred.
 Development expenditures meet
certain criteria (i.e., development costs
can be measured , the product is
technically and commercially feasible
and the economic benefits are
probable) are capitalized as an
intangible asset.
Intangible Assets 31
7. Computer Software Costs
 Computer software costs including planning,
designing, coding, testing, documentation
and preparation of training materials.
 Expense most of the costs if the software is
to be sold.
 SFAS 86 requires these costs be expensed
as R & D expenses prior to the
establishment of technological feasibility of
the software.
Intangible Assets 32
Costs Associated With a Software
 Costs occurred after the establishment
of technological feasibility but before
the software is ready for general release
are capitalized as an intangible asset.
 Costs occurred after the software is
ready for general release and
production are recognized as produce
costs (will be expensed as CGS later).
Intangible Assets 33
8. Goodwill
 Cannot be separated from the business.

 Can only be recognized if the whole

business was purchased and the
purchase price is greater than the
market value of the net assets (i.e.,
market value of assets  market value
of liabilities).
Intangible Assets 34
Factors Contribute to Goodwill
 Superior management team.
 Outstanding sales organization.
 Favorable tax condition.
 Effective advertising.
 Good labor relations.
 Outstanding credit rating.
Intangible Assets 35
Methods of Measuring Goodwill
 Theoretically, estimate the value of
each factor which contributes to the
goodwill (not practical).

 There are two alternatives used in

measuring goodwill:
a. Master valuation approach.
b. Capitalization of excess earnings
power.
Intangible Assets 36
a. Master Valuation Approach
 Goodwill1 = Purchase price of a
business - market value of net assets of
the business.

Market value of net assets

= M.V. of assets - M.V. of liabilities.

1. Goodwill is measured as the excess of cost

over the fair value of the identifiable net assets
acquired.
Intangible Assets 37
b. Capitalization of Excess Earnings
Power
 Excess earnings power = the difference
between what a firm earns and what is
normally earned for a similar firm in the
same industry.

 Goodwill = Discounting the excess

earnings over the estimated life of the
excess earnings.
Intangible Assets 38
b. Capitalization of Excess Earnings
Power (contd.)
 Example
Excess earning = $10,000
Discount Rate = 10%
Estimated life = 10 years
 Goodwill = $10,000 x 6.145 = $61,450

annuity, 10 -period, 10%

Intangible Assets 39
b. Capitalization of Excess Earnings
Power (contd.)
 Excess Earnings = annual average
earnings of a firm (excluding
extraordinary items)  normal annual
earnings of a similar firm in the
industry.
 Normal earnings = industry rate of
return on assets  the market value of
the acquired firm’s net assets.
Intangible Assets 40
Goodwill (contd.)
 Recording of Acquisition:
Assets (at market value) xxx
Goodwill xxx
Liability (at market value) xxx
Cash xxx

Intangible Assets 41
Goodwill (contd.)
 Amortization of goodwill is abolished by
SFAS No. 142, effective July 2002.
 Goodwill is subject to impairment tests
at least annually.
 See the notes in chapter 11 for Assets
Impairment for the goodwill impairment
procedures.

Intangible Assets 42
Negative Goodwill
 Negative Goodwill: Cannot be recognized.

(in the case when price paid is less than

the market value of the net assets)
 The negative goodwill is used to reduce
the costs assigned to the noncurrent
assets acquired. The reduction is
proportionately to the relative market
value of the noncurrent assets.
Intangible Assets 43
Impairment of Intangible Assets
(see Impairment Notes in Ch. 11 for Details)
 All principles (SFAS 144) apply to
impairments of long-lived assets also
apply to intangible assets.
 Thus, when changes in circumstances
indicate that the book value of the
intangibles may not be reconcilable (i.e.,
fair value of intangible < carrying amount),
a write-down should be performed to
recognize the loss.
Intangible Assets 44
Impairment of Intangible Assets
(contd.)
 Example:
Carrying amount of a copyright $1,200,000
Fair value 500,000
Loss on Impairment $700,000

The journal entry to record the loss:

Loss on Impairment 700,000
Copyright 700,000

Intangible Assets 45
Summary of the Chapter
Intangible Legal Life Amortization
Patent 20 The shorter of useful or
legal life
Copyrights Life of creator + 70 The shorter of useful or
years legal life not to exceed
40 years
Franchises or Contractual The shorter of
Licenses agreements contractual Life or
useful life
Trade Names & Unlimited (renewed Impairment test only
Trademarks every 10 years) (at least annually)
In-Process R&D Unlimited Impairment test only
Goodwill Unlimited Impairment test only
Intangible Assets 46