CHAPTER 12 Intangible Assets ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Intangible assets; concepts, definitions; items comprising intangible assets 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14 Patents; franchise; organization costs; trade name 9, 10, 11, 25 Goodwill Brief Exercises Exercises Concepts Problems for Analysis 1, 2, 3, 5, 1, 2, 3, 1, 2, 1, 2, 3, 4, 7, 12, 13 4, 5, 6, 7, 8, 9, 10, 11, 13 1, 2, 3, 4, 1, 12, 13, 14, 18 5, 7, 6, 12, 13, 15 5, Impairment of intangibles 15, 16, 17, 18 6, 7, 14, 15 Research and development costs and similar costs 19, 20, 21, 22, 23, 24 9, 10, 11, 12 4, 16, 17 1, 2, *6 Computer software costs 26, 27, 28 14 18, 19 3, 4, *This material is covered in an Appendix to the chapter Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-1 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems Describe the characteristics of intangible assets 1, 2, Identify the costs to include in the initial valuation of intangible assets 1, 2, 3, 5, 7, 9, 10, 11 1, 2, 3, Explain the procedure for amortizing intangible assets 1, 2, 3, 4, 12, 13 4, 5, 6, 7, 9, 10, 11, 13 1, 2, 3, Describe the types of intangible assets 1, 2, Explain the conceptual issues related to goodwill 12, 13 56 ExplainDescribe the accounting issuesprocedures for recording goodwill 12, 13, 15 5, 67 Explain the accounting issues related to intangibleasset impairments 6, 7, 14, 15 5, 78 Identify the conceptual issues related to research and development costs 5, 89 Describe the accounting for research and development and similar costs 9, 10, 11, 12 910 Indicate the presentation of intangible assets and related items 12, 13 *11 Understand the accounting treatment for computer software costs 14 4, 6, 8, 16, 17 4, 18, 19 *This material is covered in an Appendix to the chapter 12-2 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use ASSIGNMENT CHARACTERISTICS TABLE It e m Description Level of Difficu lty Time (minut es) E12-1 Classification issues—intangibles Moderate 15–20 E12-2 Classification issues—intangibles Simple 10–15 E12-3 Classification issues—intangible asset Moderate 10–15 E12-4 Intangible amortization Moderate 15–20 E12-5 Correct intangible asset account Moderate 15–20 E12-6 Recording and amortization of intangibles Simple 15–20 E12-7 Accounting for trade name Simple 10–15 E12-8 Accounting for organization costs Simple 10–15 E12-9 Accounting for patents, franchises, and R&D Moderate 15–20 E12-10 Accounting for patents Moderate 20–25 E12-11 Accounting for patents Moderate 15–20 E12-12 Accounting for goodwill Moderate 20–25 E12-13 Accounting for goodwill Simple 10–15 E12-14 Copyright impairment Simple 15–20 E12-15 Goodwill impairment Simple 15–20 E12-16 Accounting for R&D costs Moderate 15–20 E12-17 Accounting for R&D costs Moderate 10–15 *E12-18 Accounting for computer software costs Moderate 10–15 *E12-19 Accounting for computer software costs Moderate 15–20 P12-1 Correct intangible asset account Moderate 15–20 P12-2 Accounting for patents Moderate 20–30 P12-3 Accounting for franchise, patents, and trade name Moderate 20–30 P12-4 Accounting for R&D costs Moderate 15–20 P12-5 Goodwill, impairment Complex 25–30 P12-6 Comprehensive intangible assets Moderate 30–35 CA12-1 Accounting for pollution expenditure Moderate 25–30 CA1212 Accounting for pre-opening costs Moderate 20–25 CA1223 Accounting for patents Moderate 25–30 CA1234 Accounting for research and development costs Moderate 25–30 Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-3 CA1245 12-4 Only) Accounting for research and development costs Moderate 20–25 Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use LEARNING OBJECTIVES 78 89 910 *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 accountingconceptual issues for recordingrelated 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 Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-5 CHAPTER REVIEW *Note: All asterisked (*) items relate to material contained in the Appendix to the chapter Chapter 12 discusses the basic conceptual and reporting issues related to intangible assets Characteristics of Intangibles Valuing and Amortizing Intangibles (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 Valuation of Intangibles (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 use—for example, purchase price, legal fees, and other incidental expenses When intangibles are acquired in exchange 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 (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 over its expected useful life.; A an intangible asset with an indefinite life is not amortized Limited-Life Intangibles The expiration of intangible assets is called amortization Limited-life intangibles should be amortized by systematic charges to expense over their respective useful lifelives The useful life should reflect the periods over which these assets will contribute to cash flows 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 12-6 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use 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 Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-7 Marketing-Related Intangible Assets (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 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, and is not renewable 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) Costs of defending a copyright are capitalized 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 They can have limited or indefinite lives The cost of a contract-related intangible 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 13 A One contract-related intangible asset is a franchise, is an contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or 12-8 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area 14 A license or permit is a contract 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 Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-9 Technology-Related Intangible Assets 1315 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 All unrecovered legal fees and other costs incurred in successfully defending & patent are charged to the patent account The costs of the patent should be amortized over its legal life or its useful life, whichever is shorter Goodwill 1416 (L.O and 6) Goodwill is the excess of cost over fair value of the identifiable net assets acquired when purchasing a business 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 accountsit is recorded only when an entire business is purchased To record goodwill, the fair value of the net tangible and identifiable intangible assets are compared with the purchase price of the acquired business Goodwill is considered to have an indefinite life and therefore should not be amortized 17 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 of Limited-Life Intangibles 1518 (L.O 67) The rules that apply to impairments of property, plant, and equipment also apply to limited-life intangibles 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 equipmentthe asset is has been impaired, a recoverability test is used The first step of the test requires, an estimate of the future net cash flows expected from the use of that asset and its eventual disposition are to be 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 The company then uses the fair value test to measure the impairment loss If an impairment loss has been incurred, it is the amount by whichby comparing the carrying amount of the asset exceeds with its fair value The impairment loss is reported as part of income from continuing operations, generally in the “Other expenses and losses” section Impairments of Indefinite-Life Intangibles 1619 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 asset’s carrying amount If the fair value of the intangible asset is less than the carrying amount, impairment is recognized 12-10 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use FG (L.O 109) Presentation of Intangibles and Related Items Intangibles: are usually reported at their unamortized cost a All intangibles other than goodwill should be combined together and reported as a separate line item b If goodwill is present, it should be reported as a separate line item c The income statement should reflect: (1) Amortization expense and impairment losses for all intangibles other than goodwill (2) Goodwill impairment losses should be shown as a separate item in continuing operations d The notes to the financial statements should include: (1) Aggregate estimated amortization expense for each of next years (2) Changes in the carrying amount of goodwill during the period R&D costs: Tthe footnotes should disclose the total R&D costs charged to expense in each period for which an income statement is presented Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-27 G Appendix 12-A Accounting for Computer Software Costs Companies can purchase or create software for external use or for internal use a Costs incurred creating a computer software product are expensed as R&D until technological feasibility has been established b Technological feasibility is established when a detailed program design or working model has been completed Costs of software used internally a Capitalize and amortize: (1) software used internally (2) upgrading and enhancing computer programs b Expense: 12-28 Only) (1) training costs (2) costs of software that don’t pan out Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Amortization of capitalized costs a Use the greater of the: (1) ratio of current revenues to current and anticipated revenues (percent-ofrevenue approach), or (2) straight-line method over the remaining useful life of the asset (straight-line approach) b These rules can result in the use of the percent-of-revenue approach one year and the straight-line approach in another Reporting software costs a Valued at the lower of unamortized cost or net realizable value (1) Writedowns reduce the carrying value of the software costs (2) There may not be any subsequent recoveries b Disclosures include: (1) unamortized software costs, and (2) the total amount charged to expense and amounts, if any, written down to net realizable value Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-29 *H (L.O 10) 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 RELEVANT FACTS a Similarities (1) 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 (2) With issuance of a recent converged statement on business combinations (IFRS and SFAS No 141—Revised), 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 (3) 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 b Differences (1) IFRS permits revaluation on limited-life intangible assets Revaluations are not permitted for goodwill and other indefinite-life intangible assets (2) 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 12-30 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use (3) IFRS requires an impairment test at each reporting date for long-lived assets and intangibles, and records an impairment if the asset’s carrying amount exceeds its recoverable amount The recoverable amount is the higher of the asset’s 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 asset’s fair value (4) 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 (5) Under IFRS, costs in the development phase of an research and development project are capitalized once technological feasibility (referred to as economic viability) is achieved (6) (7) 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 (8) With issuance of a recent converged statement on business combinations (IFRS and SFAS No 141—Revised), 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 (9) 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 (10) IFRS permits revaluation on limited-life intangible assets Revaluations are not permitted for goodwill and other indefinite-life intangible assets (11) 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 Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-31 (12) IFRS requires an impairment test at each reporting date for long-lived assets and intangibles and records’ an impairment if the asset’s carrying amount exceeds its recoverable amount The recoverable amount is the higher of the asset’s 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 asset’s fair value (13) 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 (14) With issuance of a recent converged statement on business combinations (IFRS and SFAS No 141—Revised), 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 12-32 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use ILLUSTRATION 12-1 ACCOUNTING TREATMENT OF INTANGIBLES Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-33 ILLUSTRATION 12-2 TYPES OF INTANGIBLE ASSETS 12-34 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use ILLUSTRATION 12-3 RECORDING GOODWILL Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-35 ILLUSTRATION 12-3 (continued) 12-36 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use ILLUSTRATION 12-4 ACCOUNTING FOR IMPAIRMENT OF LIMITED-LIFE INTANGIBLES Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-37 ILLUSTRATION 12-5 CALCULATING AND RECORDING AN IMPAIRMENT LOSS FOR PATENTS 12-38 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use ILLUSTRATION 12-6 IMPAIRMENT OF INDEFINITE-LIFE INTANGIBLES—OTHER THAN GOODWILL Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-39 ILLUSTRATION 12-7 IMPAIRMENT OF GOODWILL 12-40 Only) Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use ILLUSTRATION 12-8 RESEARCH AND DEVELOPMENT COSTS Copyright © 20132012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 1514/e Instructor’s Manual (For Instructor Use Only) 12-41 ... Simple 15–20 E12-7 Accounting for trade name Simple 10–15 E12-8 Accounting for organization costs Simple 10–15 E12-9 Accounting for patents, franchises, and R&D Moderate 15–20 E12-10 Accounting for... Simple 15–20 E12-16 Accounting for R&D costs Moderate 15–20 E12-17 Accounting for R&D costs Moderate 10–15 *E12-18 Accounting for computer software costs Moderate 10–15 *E12-19 Accounting for computer... Moderate 30–35 CA12-1 Accounting for pollution expenditure Moderate 25–30 CA1212 Accounting for pre-opening costs Moderate 20–25 CA1223 Accounting for patents Moderate 25–30 CA1234 Accounting for research