Lecture Notes for Chapter 12


I. Characteristics of Intangible assets

A. We have just finished two chapters dealing with plant assets.

1. To be classified as PP&E an asset must possess three characteristics:

a. Tangible,

b. Long lived,

c. and used in operations.

2. What characteristics must intangible assets have?

1. Intangible assets lack physical existence. You cannot touch them. Most intangible assets are legal rights.

2. Intangible assets are not financial instruments.

3. Usually, intangible assets are long-term assets.

B. The more common types of intangibles are:

1. patents

2. copyrights

3. franchises



6.and tradenames.

II. Valuation

A. Purchased Intangibles are recorded at cost.

1. Cost includes all costs of acquisition and expenditures necessary to make the intangible asset ready for its intended use.

2. If intangibles are acquired for assets other than cash, then the cost of the intangible is the fair market value of the consideration given or the fair market value of the intangible received, whichever is more clearly evident.

B. Internally-Created Intangibles

1. are expensed as incurred.

2. The only internal costs capitalized are direct costs incurred in obtaining the intangible, such as legal costs.

III. Amortization of Intangible Assets

  1. Intangibles have either a limited useful life or an indefinite useful life.

1. Intangibles with a limited life are amortized. Intangible assets should be amortized by systematic charges to expense over their useful lives.

2. Intangibles with an indefinite life are not amortized.

      1. However, they must be tested each year for impairment.
      2. That is, the fair value of the asset must be compared with the book value. If book value exceeds fair value, then a loss must be recognized and the carrying value of the asset must be written down.

 IV. Categories

  1. There are six major categories of intangibles.
    1. Marketing related
    2. Customer related
    3. Artistic related
    4. Contract related
    5. Technology related
    6. Goodwill

B. Marketing related

1. Trademarks and Trade Names are words, phrases, or symbols that distinguish or identify a particular enterprise or product.

a. Registration of the trademark or trade name provides for an indefinite number of renewals for periods of 10 years each.

b. If the trademark or tradename is externally acquired, the purchase price is capitalized.

c. If internally developed, then only expenditures directly related to securing the legal right may be capitalized. This excludes any R&D costs.

C. Customer Related

1. The cost of a purchased customer list is capitalized,

2. And amortized over its useful life.

D. Artistic Related

1. Copyrights are an exclusive right to reproduce and sell an artistic or published work.

a. This right is granted for the life of the creator plus 50 years.

b. Copyrights may be sold.

c. For an internally developed artistic or published work, only the legal fees are capitalizable.

d. For an externally acquired artistic or published work, the acquisition cost is capitalizable, along with any legal fees to defend the copyright.

E. Contract Related

1. Franchises and Licenses

a. A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or services and to use certain trademarks or trade names or to perform certain functions usually within a designated geographical area.

b. A second type of franchise deals with a governmental body and a business entity, which is permitted to use public property in performing its services.

c. Any costs identified with the acquisition of the operating right should be capitalized to the intangible asset account entitled franchise of license.

d. The cost of the franchise should be amortized as an operating expense over the life of the franchise.

F. Technology Related

1. Patents

a. A patent is an exclusive right to use, manufacture, and sell a product or process for a period of 20 years without interference or infringement by others.

b. If a patent is purchased, the purchase price represents its cost.

c. If a patent is internally developed, only the legal fees to file and defend the patent are capitalized.

d. All R&D costs are charged to expense as incurred.

e. Patents are amortized over their legal life or their useful life, whichever is shorter.

G. Goodwill

1. What is goodwill?

a. Goodwill is an unidentifiable, inseparable, intangible asset.

b. It is unidentifiable because it cannot be identified separately from the firm as a whole.

1. It is comprised of many advantageous factors and conditions that might contribute to the value and the earning power of an enterprise.

2. Goodwill is recorded only when an entire business is purchased because goodwill is a going concern valuation and cannot be separated from the business as a whole.

3. Goodwill generated internally is not capitalized.

2. Recording Goodwill

a. Goodwill is the excess of cost over fair value of the identifiable net assets acquired.

b. Consequently, goodwill can be viewed as a residual value.

c. In terms of double entry bookkeeping it is a plug figure.

3. Goodwill Write Off

a. Goodwill acquired in a business combination is considered to have an indefinite life and therefore should not be amortized.

b. Income statements are not charged unless goodwill has been impaired.

4. Negative Goodwill or Badwill

a. Bad will or negative goodwill arises when the purchase price of the firm is less than the fair market value of the identifiable net assets.

b. The excess is recognized as an extraordinary gain at the time of purchase.

 V. Impairment of Intangible Assets

A.     The rules for the impairments of long-lived assets apply to limited life intangibles.

B.     Whenever events or changes indicate that the carrying amount of the assets may not be recoverable:

1. A recoverability test is performed. Estimated net future cash flows from the use and disposal of the asset are compared to the carrying value of the asset.

2. If the estimated future cash flows are less than the carrying value, then impairment has occurred.

3. If the asset fails the recoverability test, the amount of the impairment must be measured through use of the fair value test.

4. The amount of the impairment is the difference between the fair value and carrying value of the asset.

5. Recovery of a previously recognized impairment loss is not permitted.

C. Indefinite Life intangibles:

1. Should be tested for impairment at least once a year,

2. Only the fair value test is used.

D. Goodwill Impairment

1. First the fair value of the reporting unit should be compared to its carrying amount including goodwill.

2. If the fair value of the reporting unit is greater than its carrying amount, then goodwill has not been impaired.

3. If the fair value of the reporting unit is less than its carrying amount, then the fair value of the (implied) goodwill must be compared to the carrying value of the goodwill to determine the amount of the impairment.

VII. Research and Development Costs

A. Research and development costs are not intangible assets.

B. However, research and development activities frequently result in something, which is patented or copyrighted.

C. As you see in the box on page 604, research and development expenditures can be quite material.

D. The difficulties in accounting for these R&D expenditures are

1. Identifying cost associated with particular R&D projects,

2. AND determining the magnitude of future benefits and length of time over which such benefits may be realized.

E. Because of these uncertainties, SFAS no. 2 requires that all research and development costs be charged to expense when incurred.

F. Costs Associated with R&D include

1. Materials, Equipment and Facilities

2. Personnel

3. Purchased Intangibles

4. Contract Services

5. and Indirect costs

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