1

Chapter 11

Intangibles
Intangibles

An
Anelectronic
electronicpresentation
presentation
by
byDouglas
DouglasCloud
Cloud
Pepperdine
PepperdineUniversity
University
 2

Objectives
Objectives
1. Explain the accounting alternatives for intangibles.
2. Understand the amortization or impairment 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, franchises, computer software
costs, and trademarks and tradenames.

Continued
Continued
 3

Objectives
Objectives
6. Account for unidentifiable intangibles
including internally developed and
purchased goodwill.
7. Understand the disclosure of intangibles.
8. Explain the conceptual issues regarding
intangibles.
9. Estimate the value of goodwill. (Appendix)
 4

Characteristics
Characteristics that
that
Distinguish
Distinguish Intangibles
Intangibles
•• There
There isis generally
generally aa higher
higher degree
degree of of uncertainty
uncertainty
regarding
regarding thethe future
future benefits
benefits that
that may
may bebederived.
derived.
•• Their
Their value
value isis subject
subject to
to wider
wider fluctuations
fluctuations
because
because itit may
may depend
depend toto aa considerable
considerable extent
extent on
on
competitive
competitive conditions.
conditions.
•• They
They may
may have
have value
value only
only toto aa particular
particular
company.
company.
•• Goodwill
Goodwill and and intangible
intangible assets
assets withwith indefinite
indefinite
lives
lives are
are not
not expensed.
expensed.
 5

Classification
Classification of
of Intangibles
Intangibles
Capitalize the cost
incurred to acquire an
Identifiable intangible assets with a
finite life and amortize
Purchased over its useful life.
Capitalize the cost
Unidentifiable incurred to acquire
(i.e., goodwill) goodwill and review
it for impairment at
least annually.
 6

Classification
Classification of
of Intangibles
Intangibles
Expense research and
development costs as incurred
Capitalize certain costs
Identifiable incurred for an intangible
asset with a finite life and
Internally amortize over its useful life
Developed
Capitalize certain costs
incurred for an intangible
asset with an infinite life and
amortize over its useful life

Unidentifiable Expense costs as incurred

 7

Accounting
Accounting of
of Intangibles
Intangibles
Accounting
Accounting for
for the
the cost
cost of
of intangibles
intangibles isis discussed
discussed
in
in FASB
FASB Statement
Statement No.No. 142
142 as
as follows:
follows:
1. Purchased Identifiable Intangibles. A
company may purchase an intangible asset
from another company. The purchase is
handled in the same manner as the acquisition
of a single asset, in a group of assets, or in an
exchange of similar or dissimilar assets.
Continued
Continued
 8

Accounting
Accounting of
of Intangibles
Intangibles
Accounting
Accounting for
for the
the cost
cost of
of intangibles
intangibles isis discussed
discussed
in
in FASB
FASB Statement
Statement No.No. 142
142 as
as follows:
follows:
2. Purchased Unidentifiable Intangibles. A
company capitalizes the cost of a purchased
unidentifiable intangible asset. The principal
example of an unidentifiable intangible is
goodwill.

Continued
Continued
 9

Accounting
Accounting of
of Intangibles
Intangibles
Accounting
Accounting for
for the
the cost
cost of
of intangibles
intangibles isis discussed
discussed
in
in FASB
FASB Statement
Statement No.No. 142
142 as
as follows:
follows:
3. Internally Developed Identifiable Intangibles.
When a company internally develops an
intangible assets, it can capitalize only certain
costs. The expensing of research and
development costs represents an exception to
the general rule of capitalizing of internally
developed identifiable intangibles.
Continued
Continued
 10

Accounting
Accounting of
of Intangibles
Intangibles
Accounting
Accounting for
for the
the cost
cost of
of intangibles
intangibles isis discussed
discussed
in
in FASB
FASB Statement
Statement No.No. 142
142 as
as follows:
follows:
4. Internally Developed Unidentifiable
Intangibles. A company expenses the costs of
internally developed unidentifiable intangibles
as incurred even thought they may be expected
to have benefits extending beyond the current
period.
 11

Amortization
Amortization of
of Intangibles
Intangibles
Intangible
Intangible Assets
Assets
With
With aa Finite
Finite Life
Life
Are
Are Amortized.
Amortized.

The calculation of the

amortization of intangible
assets follows the same
principles as the depreciation
of tangible assets.
 12

Amortization
Amortization of
of Intangibles
Intangibles
AA company
company purchases
purchases aa patent
patent for
for $85,000.
$85,000.
Patent 85,000
Cash 85,000
At
At year-end
year-end the
the patent
patent isis amortized
amortized over
over 10
10
years
years (no
(no expected
expected residual
residual value).
value).
Amortization Expense (or
Factory Overhead) 8,500
Accumulated Amorti-
zation: Patent 8,500
 13

Impairment
Impairment of
of an
an Intangible
Intangible
A
A company
company purchased
purchased aa trademark
trademark several
several years
years
ago
ago for
for $60,000.
$60,000. As As the
the company
company considered
considered the the
trademark
trademark to to have
have an
an indefinite
indefinite life,
life, the
the trademark
trademark
has
has aa carry
carry value
value of
of $60,000.
$60,000. At At the
the end
end ofof the
the
current
current year,
year, the
the company
company determines
determines thatthat the
the fair
fair
value
value of
of the
the trademark
trademark isis $20,000.
$20,000. An An entry
entry isis
needed
needed toto record
record the
the$40,000
$40,000 loss
loss inin fair
fair value.
value.
Impairment Loss on Trademark 40,000
Trademark 40,000
 14

Research
Research and
and Development
Development Costs
Costs

•• Research
Research isis the
the planned
planned search
search or
or critical
critical
investigation
investigation aimed
aimed at at discovery
discovery of of new
new
knowledge.
knowledge.
•• Development
Development isis thethe translation
translation ofof research
research
findings
findings or
or other
other knowledge
knowledge into into aa plan
plan or
or
design
design for
for aa new
new product
product or or process
process or or for
for aa
significant
significant improvement
improvement to to an
an existing
existing
product
product or
or process.
process.
 15

Research
Research and
and Development
Development Costs
Costs

Costs
Costs associated
associated with
with
activities
activities excluded
excluded
from
from R&D
R&D are are either
either
expensed
expensed or or
capitalized
capitalized according
according
to
to normal
normal
capitalization
capitalization criteria.
criteria.
 16

Research
Research and
and Development
Development Costs
Costs
Expenditures for the following elements of R&D
activities are included in R&D costs and thus expensed
as incurred:
 Materials, equipment, and facilities
 Personnel
 Intangibles purchased from others
 Contract services
 Indirect costs—R&D includes a
reasonable allocation of indirect costs.
 17

Research
Research and
and Development
Development Costs
Costs
Kent Company incurred the following costs for R&D
activities:
Materials used from inventory $50,000
Wages and salaries 90,000
Allocation of general and administrative
costs 20,000
Depreciation on building housing R&D
activities 25,000
Machine purchased for R&D project that
has no alternative future uses 30,000
Continued
Continued
 18

Research
Research and
and Development
Development Costs
Costs
The company includes all these costs in R&D
expenses, and records them as follows:

Research and Development Expense 215,000

Cash, Payables, etc. 140,000
Inventory 50,000
Accumulated Depreciation, Building 25,000
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Identifiable
Identifiable Intangible
Intangible Assets
Assets
R&D
In period
cost incurred
Cost Identifiable Intangible
Cost of
of
Intangibles Assets That Are Expense
Intangibles
Typically Amortized
Patents
Amortize
Copyrights over
Franchises service
Computer Software life
Continued
Continued Costs
Leasehold Improvements
 20

Identifiable
Identifiable Intangible
Intangible Assets
Assets

Identifiable Intangible
Assets That Are
Cost Typically Reviewed for Recognize
Cost of
of
Intangibles Impairment loss when
Intangibles
Trademarks and impaired
tradenames
Licenses that may be
renewed indefinitely
Continued
Continued
 21

Identifiable
Identifiable Intangible
Intangible Assets
Assets

Unidentifiable
Cost Intangible Assets That Recognize
Cost of
of
Intangibles Are Reviewed for loss when
Intangibles
Impairment impaired
Goodwill
 22

Patents
Patents
…of
AA patent
…of the
the manufacture,
patent isis an
an exclusive
manufacture,
exclusivesale,
right
sale, or
right
or
other
granted
other use
use of
granted ofbyan
byanthe
invention
the federal
federalfor
invention for
government
20
20 years
years from
government giving
from the
givingthethe
date
the owner
date of
owner
of
control…
filing.
control…
filing.
 23

Patents
Patents
A
A company
company can can capitalize
capitalize the
the costs
costs
of
of successfully
successfully defending
defending the the legal
legal
validity
validity of of aa patent.
patent. IfIf the
the suit
suit isis
lost,
lost, all
all legal
legal costs
costs are
are expensed.
expensed.
 24

Copyrights
Copyrights
A
A copyright
copyright isis aa grant
grant byby the
the federal
federal
government
government to to publish,
publish, sell
sell or
or otherwise
otherwise
control
control literary
literary oror artistic
artistic products
products for
for
the
the life
life of
of the
the author
author plus
plus 7070 year.
year.

Books
© Music
Films
 25

Franchises
Franchises
Franchises are agreements 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 King
McDonald’s
Midas Muffler
KFC
 26

Computer
Computer Software
Software Costs
Costs

R & D Expense Capitalize Expense

Technological General
Feasibility Release

Technological feasibility is established

either on the date the company completes
a detail program design or, in its absence,
when it completes a working model of
the product.
 27

Computer
Computer Software
Software Costs
Costs

Internal-Use
Internal-Use Software
Software
AICPA Statement of Position No. 98-1 specifies that
the capitalization of costs begins when---
(1) the preliminary stage is completed,
(2) management authorizes and commits to funding
a company software project, and
(3) interest costs are incurred when developing the
software.
 28

Trademarks
Trademarks and
and Tradenames
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 used for product
identification for 20 years. The right is renewable
indefinitely as long as it is used continuously.
 29

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

Legal fees, stock certificate costs,

underwriting fees, accounting fees,
promotional fees
 30

Goodwill
Goodwill
Purchased
Purchased goodwill
goodwill
arises
arises whenwhen aa company
company
isis acquired.
acquired. ItIt isis the
the
difference
difference between
between the the
purchase
purchase priceprice of
of the
the
acquired
acquired company
company as as aa
whole
whole and
and the
the fair
fair
value
value of of the
the reported
reported
identifiable
identifiable net net assets.
assets.
 31

Goodwill
Goodwill
Sara
Sara Company
Company purchases
purchases all all the
the assets
assets of
of Trevor
Trevor Company
Company
for
for $790,000
$790,000 cash
cash and
and Trevor
Trevor Company
Company isis dissolved.
dissolved.
Trevor
Trevor Company’s
Company’s identifiable
identifiable assets
assets had
had aafair
fair value
value of
of
$920,000
$920,000 and
and its
its liabilities
liabilities totaled
totaled $200,000.
$200,000.
Assets 920,000
Goodwill 70,000
Liabilities 200,000
Cash 790,000
Individual assets and liabilities
actually would be debited or credited.
 32

Impairment
Impairment of
of Goodwill
Goodwill
A
A company
company must
must review
review
its
its goodwill
goodwill for
for
impairment
impairment annually
annually at
at
the
the reporting
reporting unit
unit level.
level.
 33

Impairment
Impairment of
of Goodwill
Goodwill
A
A company
company must must also
also review
review its
its
goodwill
goodwill for
for impairment
impairment whenever
whenever
events
events oror changes
changes in in circumstances
circumstances
occur
occur that
that would
would more-likely-than-
more-likely-than-
not
not reduce
reduce the
the fair
fair value
value of
of the
the
goodwill
goodwill below
below its
its carrying
carrying value.
value.
 34

Impairment
Impairment of
of Goodwill
Goodwill
The Kent Company acquired the Devon Company as a
subsidiary several years ago. The Devon Company has a
book value of $3.6 million, including goodwill of $400,000.
Kent Company estimates that its fair value is $3 million. If
Kent Company allocates $2.7 million of the fair market
value to Devon Company’s identifiable assets and liabilities,
this means that $300,000 is implied for goodwill. Thus,
there has been an impairment loss of $100,000.
Impairment Loss on Goodwill 100,000
Goodwill 100,000
 35

Disclosure
Disclosure of
of Intangibles
Intangibles
FASB
FASB Statement
Statement No.
No. 142142 requires
requires aa company
company toto
disclose
disclose certain
certain information
information about
about its
its intangible
intangible assets,
assets,
in
in either
either the
the financial
financial statement
statement oror itit notes,
notes, including:
including:
1. In the period it acquires intangible assets:
a. The cost of any intangible asset acquired, separated
into categories.
b. For assets subject to amortization, the residual
value and the weighted-average amortization
expense for the next five years.
c. The cost of any R&D acquired and written off, and
where it is included in the income statement.
Continued
Continued
 36

Disclosure
Disclosure of
of Intangibles
Intangibles
FASB
FASB Statement
Statement No.
No. 142
142 requires
requires aa company
company toto
disclose
disclose certain
certain information
information about
about its
its intangible
intangible assets,
assets,
in
in either
either the
the financial
financial statement
statement or
or itit notes,
notes, including:
including:
2. In each period for which it presents a balance sheet:
a. For intangible assets that are amortized, the total
cost, the accumulated amortization, the
amortization expense, and the estimated
amortization expense for the next five years.
b. For intangible assets that are not amortized, the
total cost and the cost of each major intangible
asset class. Continued
Continued
 37

Disclosure
Disclosure of
of Intangibles
Intangibles
FASB
FASB Statement
Statement No.
No. 142
142 requires
requires aa company
company toto
disclose
disclose certain
certain information
information about
about its
its intangible
intangible assets,
assets,
in
in either
either the
the financial
financial statement
statement or
or itit notes,
notes, including:
including:
2. In each period for which it presents a balance sheet:
c. For goodwill, the amount of goodwill acquired, the
amount of any impairment losses recognized, and
the amount of goodwill included in the disposal of
a reporting unit.
d. For any intangible asset impairment, the facts and
circumstances leading to the impairment, the
amount of the loss, and the method used.
 38

Conceptual
Conceptual Issues
Issues
Expensing
Expensing internally
internally generated
generated goodwill
goodwill isis justified
justified
on
on the
the basis
basis that
that measuring
measuring the the cost
cost of
of internally
internally
generated
generated goodwill
goodwill with
with aa reasonable
reasonable degree
degree of of
reliability
reliability isis very
very difficult.
difficult.

Capitalization
Capitalization of of internally
internally generated
generated goodwill
goodwill
would
would require
require amortization.
amortization. ItIt would
would be
be very
very
difficult
difficult to
to identify
identifythetherevenues
revenuesgenerated
generatedand
and
therefore
therefore toto decide
decideoverover which
which periods,
periods, and
and by
by
which
which method,
method, to to match
match the
the amortization
amortization expenses
expenses
against
against thethe benefits.
benefits.
 39

Appendix:
Appendix:
Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill

Click here to skip Appendix material.

 40

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix
(Appendix)
(Appendix
1. Estimate the average future earnings from the
identifiable net assets.
2. Estimate the rate of return that should be earned
by the company on its identifiable net assets.
3. Estimate the current fair value of the identifiable
net assets.
4. Compute the estimated excess annual earnings.

Continued
Continued
 41

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
5. Estimate the expected life of the excess annual
earnings.
6. Compute the present value of the estimated excess
annual earnings.
7. Compute
Two the total value
additional of may
steps the company
follow being
the
Two additional steps may follow the
considered for purchase.
calculation
calculation of
ofthe
thevalue
value of
of goodwill:
goodwill:
8. Apply sensitivity analysis.
 42

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 1: Estimate the average future earnings.
Select a number of years to determine the trend of the
firm’s earnings.
1. Eliminate unusual gains or loss, extraordinary
items, the results of discontinued operations, and
the effects of changes in accounting principles.
2. Adjust for differences in accounting principles.
 43

Greenfield Company
Average annual revenue $628,000
Average annual cost of goods sold $266,000
Average operating expense 180,000
Expected annual increase in wages not to
be recovered by increased revenues 40,000
Increase in annual depreciation on the
current fair value of the assets 12,000
Annual amortization of new intangibles 10,000
Expected expenses (508,000)
Expected average annual earnings before taxes $120,000
Estimated income taxes (30%) (36,000)
Expected average annual earnings $84,000
 44

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 2: Estimate the rate of return.
Based
Based on on the
the risk
risk of
of the
the
investment,
investment, Greenfield
Greenfield
assumed
assumed aa 10%
10% return
return
after
after income
income taxes.
taxes.
 45

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 3: 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 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
 46

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 4: 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
 47

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 5: Estimate the expected life of excess
annual earnings.
Greenfield Company estimates
that the excess annual earnings
will last for ten years.
 48

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 6: Compute the present value of the
estimated excess annual earnings.
Estimated
Estimated excess
excess annual
annual earnings
earnings $12,000
$12,000
Present
Present value
valuefactor
factor for
for an
an annuity
annuity of
of
10
10 periods
periods at
at 10%
10% xx 6.144567
6.144567
Present
Present value
valueofof estimated
estimated excess
excess
annual
annual earnings
earnings (goodwill)
(goodwill) $73,735
$73,735
 49

Steps
Steps Used
Used In
In Estimating
Estimating the
the
Value
Value of
of Goodwill
Goodwill (Appendix)
(Appendix)
STEP 7: Compute the total value of the
company.
Fair
Fair value
value of
of the
the assets
assets $720,000
$720,000
Goodwill
Goodwill 73,735
73,735
Total
Total value
value of
of the
the company
company $793,735
$793,735

STEP 8: Apply sensitivity analysis.

 50

Chapter 11

The
The End
End
51