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IntangiblesIntangibles

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1. Explain the accounting alternatives for intangible assets.

2. Record the amortization of intangibles.3. Identify research and development costs.4. Explain the conceptual issues for research and

development costs.5. Account for identifiable intangible assets including

patents, copyrights, trademarks and tradenames, franchises, and computer software costs.

ObjectivesObjectives

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6. Account for unidentifiable intangibles including internally developed and purchased goodwill.

7. Understand goodwill amortization.

8. Understand the disclosure of intangibles.

9. Explain the conceptual issues regarding intangibles.

10. Estimate the time value of goodwill.

ObjectivesObjectives

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Characteristics that Distinguish Intangibles

Characteristics that Distinguish Intangibles

• There is generally a higher degree of uncertainty regarding the future benefits that may be derived.

• Their value is subject to wider fluctuations because it may depend to a considerable extent on competitive conditions.

• They may have value only to a particular company.

• They may have indeterminate (but not necessarily indefinite) lives.

• There is generally a higher degree of uncertainty regarding the future benefits that may be derived.

• Their value is subject to wider fluctuations because it may depend to a considerable extent on competitive conditions.

• They may have value only to a particular company.

• They may have indeterminate (but not necessarily indefinite) lives.

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Classification of IntangiblesClassification of Intangibles

Purchased

IdentifiableCapitalize and amortize over the economic life, not to exceed 40 years

Unidentifiable (goodwill)

Capitalize and amortize over the economic life, not to exceed 40 years

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Classification of IntangiblesClassification of Intangibles

Internally Developed

Identifiable

Capitalize and amortize over the economic life, not to exceed 40 years, except research and development, which is expensed as incurred

Unidentifiable Expense as incurred

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Amortization of IntangiblesAmortization of Intangibles

Legal, regulatory, or contractual provisions that place a limit on the maximum economic life.

Provisions for renewal or extension of rights or privileges covered by specific intangible assets.

Effects of obsolescence, customer demand, competition, rate of technological change, and other economic factors.

Factors to consider when estimating the useful life of an intangible asset:

Factors to consider when estimating the useful life of an intangible asset:

ContinuedContinuedContinuedContinued

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Amortization of IntangiblesAmortization of Intangibles

Possibility that the economic lives of intangibles may be related to life expectancies of certain groups of employees.

Expected actions of competitors, regulatory bodies, and others.

An apparently unlimited economic life cannot be reasonably projected.

An intangible may be a composite of many factors.

Factors to consider when estimating the useful life of an intangible asset:

Factors to consider when estimating the useful life of an intangible asset:

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Amortization of IntangiblesAmortization of Intangibles

The estimated life of an intangible should be made after considering all relevant factors, but in no case may

it exceed 40 years.

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Amortization of IntangiblesAmortization of Intangibles

A company purchases a patent for $85,000.A company purchases a patent for $85,000.

Patent 85,000 Cash 85,000

At year-end the patent is amortized over 10 years (no expected residual value).

At year-end the patent is amortized over 10 years (no expected residual value).

Amortization Expense (or Factory Overhead) 8,500 Patent (or Accumulated Amorti- zation: Patent) 8,500

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Research and Development CostsResearch and Development Costs

• Research is the planned search or critical investigation aimed at discovery of new knowledge.

• 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.

• Research is the planned search or critical investigation aimed at discovery of new knowledge.

• 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.

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Research and Development CostsResearch and Development Costs

Costs associated with activities excluded from R&D are either

expensed or capitalized.

Costs associated with activities excluded from R&D are either

expensed or capitalized.

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Materials, equipment, and facilities Personnel Intangibles purchased from others Contract services Indirect costs

Materials, equipment, and facilities Personnel Intangibles purchased from others Contract services Indirect costs

Research and Development CostsResearch and Development Costs

Expenditures for the following elements of R&D activities are included in R&D costs and thus expensed as incurred:

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Identifiable Intangible AssetsIdentifiable Intangible Assets

Cost of Intangibles

R&D

Expense

In period cost incurred

Amortize over service life

Intangible AssetsPatentsCopyrightsTrademarks and TradenamesFranchisesComputer Software CostsLeasehold ImprovementsGoodwill

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PatentsPatents

A patent is an exclusive right granted by the federal

government giving the owner control for 20 years.

A patent is an exclusive right granted by the federal

government giving the owner control for 20 years.

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PatentsPatents

A company can capitalize the costs of successfully defending the legal validity of a patent. If the suit is lost, all legal costs are expensed.

A company can capitalize the costs of successfully defending the legal validity of a patent. If the suit is lost, all legal costs are expensed.

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CopyrightsCopyrights

©

A copyright is a grant by the federal government to publish, sell or otherwise control literary or artistic products for

the life of the author plus 70 year.

A copyright is a grant by the federal government to publish, sell or otherwise control literary or artistic products for

the life of the author plus 70 year.

BooksMusic Films

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Trademarks and TradenamesTrademarks and Tradenames

Registration of a trademark or tradename with the U.S. Patent Office establishes a right to exclusive use of a name, symbol, or other device for 20 years. The right is renewable

indefinitely as long as it is used continuously.

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FranchisesFranchises

A franchise is an agreement entered into by two parties in which, for a fee, one party gives the

other party the right to perform certain functions or sell certain products or services.

Burger KingMcDonald’s

Midas MufflerKFC

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Computer Software CostsComputer Software Costs

Technological Feasibility

General Release

R & D Expense Capitalize Expense

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The preliminary stage is completed. Management authorizes and commits to funding a

company software project. Interest costs is incurred when developing the

software.

Computer Software CostsComputer Software Costs

Internal-Use SoftwareInternal-Use Software

Capitalization of costs begins when---

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• Leases and leasehold improvements

• Deferred charges (a catch-all category in which several individually immaterial items are accumulated)

• Organization costs

Other IntangiblesOther Intangibles

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GoodwillGoodwill

Purchased goodwill is the difference between the purchase price (market

value) of the company as a whole and the fair value of the identifiable net assets.

Purchased goodwill is the difference between the purchase price (market

value) of the company as a whole and the fair value of the identifiable net assets.

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GoodwillGoodwill

Sara Company purchases all the assets of Trevor Company for $790,000 cash and Trevor Company is dissolved.

Trevor Company’s identifiable assets had a fair value of $920,000 and its liabilities totaled $200,000.

Sara Company purchases all the assets of Trevor Company for $790,000 cash and Trevor Company is dissolved.

Trevor Company’s identifiable assets had a fair value of $920,000 and its liabilities totaled $200,000.

Assets 920,000Goodwill 70,000 Liabilities 200,000 Cash 790,000

Individual assets and liabilities Individual assets and liabilities actually would be debited or credited.actually would be debited or credited.

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GoodwillGoodwill

At year-end an entry is needed to amortize the goodwill. Goodwill of $70,000 is amortized over 20 years.

At year-end an entry is needed to amortize the goodwill. Goodwill of $70,000 is amortized over 20 years.

Goodwill Amortization Expense 3,500 Goodwill 3,500

Goodwill is amortized over 15 years for computing taxable income. Therefore, there is a timing difference

between financial income and taxable income.

Goodwill is amortized over 15 years for computing taxable income. Therefore, there is a timing difference

between financial income and taxable income.

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Disclosure of IntangiblesDisclosure of Intangibles

FASB Statement No. 2 requires that a company disclose its total R&D expense either through a line

item on the company’s income statement or by notes to the financial statement.

FASB Statement No. 2 requires that a company disclose its total R&D expense either through a line

item on the company’s income statement or by notes to the financial statement.

APB Opinion No. 17 requires that a company disclose the method and period of amortization.

APB Opinion No. 17 requires that a company disclose the method and period of amortization.

The SEC requires that accumulated amortization be disclosed on filed reports.

The SEC requires that accumulated amortization be disclosed on filed reports.

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Conceptual IssuesConceptual Issues

An argument for expensing R&D is that capitalization would require amortization and it is very difficult to identify the revenues generated

against which the amortization should be matched.

An argument for expensing R&D is that capitalization would require amortization and it is very difficult to identify the revenues generated

against which the amortization should be matched.

If capitalizing purchased goodwill is supported, it can be argued that it would be more consistent also

to capitalize R&D.

If capitalizing purchased goodwill is supported, it can be argued that it would be more consistent also

to capitalize R&D.

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Estimate the average future earnings from the identifiable net assets.

Estimate the rate of return that should be earned by the company on its identifiable net assets.

Estimate the current fair value of the identifiable net assets.

Compute the estimated excess annual earnings.

ContinuedContinuedContinuedContinued

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Estimate the expected life of the excess annual earnings.

Compute the present value of the estimated excess annual earnings.

Compute the total value of the company being considered for purchase.

Apply sensitivity analysis.

Two additional steps may follow the calculation of the value of goodwill:

Two additional steps may follow the calculation of the value of goodwill:

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Estimate the average future earnings.Select a number of years to determine the trend of the firm’s earnings.

Eliminate unusual gains or loss, extraordinary items, the results of discontinued operations, and the effects of changes in accounting principles.

Adjust for differences in accounting principles.

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Average annual revenue$628,000

Average annual cost of goods sold $266,000Average operating expense 180,000Expected annual increase in wages not to

be recovered by increased revenues 40,000Increase in annual depreciation on the

current fair value of the assets 12,000Annual amortization of new intangibles 10,000Expected expenses

(508,000)Expected average annual earnings before taxes

$120,000 Estimated income taxes (30%)

(36,000)Expected average annual earnings

$ 84,000

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Estimate the rate of return.

Based on the risk of the investment, Greenfield assumed a 10% return

after taxes.

Based on the risk of the investment, Greenfield assumed a 10% return

after taxes.

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Estimate the current fair value of the identifiable net assets.

Book value of identifiable net asset $570,000 Revaluation of LIFO inventory to fair value 90,000 Increase in allowance for uncollectible accounts (10,000)Revaluation of property, plant and equipment to fair value 120,000 Fair value of fully amortized trademark 150,000 Revaluation of bonds payable (lower interest rate) (60,000)Unfunded projected benefit obligations of pension (140,000)Current fair value of identifiable net assets $720,000

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Compute the estimated excess annual earnings.

Average expected annual earnings $84,000 10% return on fair value of identi- fiable net assets (72,000)Estimated excess annual earnings $12,000

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Estimate the expected life of excess annual earnings.

Greenfield Company estimates that the excess annual earnings

will last for ten years.

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Compute the present value of the estimated excess annual earnings.

Estimated excess annual earnings $12,000Present value factor for an annuity of 10 periods at 10% x 6.144567Present value of estimated excess annual earnings (goodwill) $73,735

Estimated excess annual earnings $12,000Present value factor for an annuity of 10 periods at 10% x 6.144567Present value of estimated excess annual earnings (goodwill) $73,735

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Steps Used In Estimating the Value of Goodwill (Appendix)Steps Used In Estimating the Value of Goodwill (Appendix)

Compute the total value of the company.

Fair value of the assets $720,000Goodwill 73,735Total value of the company $793,735

Fair value of the assets $720,000Goodwill 73,735Total value of the company $793,735

Apply sensitivity analysis.

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