Transcript Document

Intangible Assets
To understand issues with intangibles, it is important to
recognize that:
• Most assets (excluding land) are simply “Delayed Expenses”
eg: You pay $100,000 to own and use a machine for 10 yrs.
Option 1 (not GAAP): Expense $100,000 in current year
Option 2 (GAAP): Record asset and expense ratably over
its useful life (depreciation)
Option 2 delays the expenses to better match revenues
Intangible Assets
Intangible Assets are assets that:
• Lack Physical Substance
• Are not Financial Instruments
- Bank Deposits, Bonds, Stocks, etc.
Examples include Patents, Goodwill, and Trademarks
Intangible Assets
Valuation
Internally-generated intangibles (like Research &
Development Costs) get expensed in the current period
In other words, internally generated intangibles may not
actually generate an asset account
However, legal fees and other processing costs can
be capitalized into the value of the asset.
Intangible Assets
Valuation
Example: Mendez Corp. incurred $210,000 of R&D costs to
develop a product for which a patent was granted on Jan 1, 2000.
Legal fees and other costs associated with registration of the
patent totaled $60,000.
On March 31, 2002, Mendez paid $90,000 for legal fees in a
successful defense of the patent.
The total amount that should be capitalized (included as cost)
for the patent (as of March 31, 2002) is:
$60,000 + $90,000 = $150,000
The R&D Costs would be expensed entirely in 2000.
Intangible Assets
Valuation
Generally, purchased intangibles get recorded as assets
Purchased Intangibles are recorded at cost, where:
Cost = expenses to acquire and prepare asset for use
Cost includes legal fees to process or defend the asset
Intangibles purchased through exchange of asset or stock
are recorded at:
FMV of intangible received or asset/stock given up,
whichever is more evident and measurable.
Intangible Assets
Valuation
Example: Paterno Corp. purchases a trademark for $400,000.
Legal and registration fees to process the trademark were $8,000.
The Trademark is recorded on Paterno’s balance sheet at:
$400,000 + $8,000 = $408,000
Intangible Assets
Valuation
Example: On May 5, 2001, Pitts Corp. exchanged 4,000
shares of its $10 par Common Stock for a patent owned by
Gore Co. Pitts also paid $2,000 to register the patent.
Gore carries the patent on its books at $110,000.
Pitts’ Common Stock traded at $32 a share on the NYSE on
May 5th, 2001.
Pitts should record the patent on its books at the FMV of the
patent received or stock given up, whichever is more evident
and measurable.
In this case, FMV of stock given up = $32 x 4,000 = $128,000
But Pitts should also include the $2,000 to register the patent.
So the asset account would hold $128,000 + $2,000 = $130,000
Intangible Assets
Types
Trademark: A word, phrase or symbol that identifies a company,
product or brand.
Carried at cost (if purchased) plus costs for:
Legal Fees
Registration Fees
Design Costs
Consulting Fees
Other expenses directly related to securing the trademark
Considered to have an indefinite life, so not amortized.
Exception: If it clearly has a limited life then it may be amortized.
Intangible Assets
Types
Copyright: Exclusive right to reproduce and sell an artistic or
published item.
Carried at cost (if purchased) plus costs for:
Legal Fees
Registration Fees
Consulting Fees
Other expenses directly related to securing the copyright
Granted for life of the creator + 50 years.
Usually the useful life is much less than this. Amortize over
the best estimate of useful life.
Intangible Assets
Types
Franchise: Contractual right to sell certain products or services,
use a trademark, and use a trade name within a certain
geographical area.
Carried at cost (if purchased) plus costs for:
Legal Fees
Registration Fees
Consulting Fees
Other expenses directly related to securing the franchise
May be indefinite life or limited life, depending on the
contract terms.
If limited life, amortize costs over limited life. If indefinite
life, do not amortize.
Intangible Assets
Types
Patent: Exclusive right to use, manufacture, and sell a product.
Carried at cost (if purchased) plus costs for:
Legal Fees (including patent defense)
Registration Fees
Consulting Fees
Other expenses directly related to securing the patent
Does not include R&D expenses to “discover” the product
Granted by the government for 20 years.
Amortize patent over 20 years or useful life, whichever is less.
Intangible Assets
Types
Goodwill: Very fuzzy concept of intangible value. The amount a
company is worth above it’s assets’ Fair Market Value.
Conceptually, it would include things like value of
employee knowledge, customer loyalty, and other
nebulous “assets” that cannot be valued on the
balance sheet.
Every company has its Goodwill. But, it is impossible
to measure internally, so no Goodwill account is
created.
However, there is one situation where we can effectively
capture some sense of this “true” or “intrinsic” value and
we can, therefore, establish a Goodwill account…
Intangible Assets
Types
Mergers and Acquisitions
The target firm of a merger has assets on its balance sheet.
These assets are recorded at book value, which is clearly not
a good indication of their true value.
So, to price this target, a buying firm must assess the Fair
Market Value of all the target’s assets.
Almost always, however, the buying firm pays more than the
sum total of the Fair Market Value for all the target firm’s
assets.
Why does the buyer overpay for these assets?
Because the buyer has some sense of the “intrinsic” or “true”
value of the “assets” that are impossible to record on the
balance sheet.
Intangible Assets
Types
Mergers and Acquisitions
In a Merger or Acquisition, we record an intangible asset called
Goodwill when:
A buyer pays more than the total FMV for all assets on the
target’s balance sheet.
Therefore, Goodwill = Amount Paid for target – FMV of
target’s assets.
Why record Goodwill now when we can’t do it otherwise?
Because, by overpaying for the target, the buyer has shown us
the “intrinsic” or “true” value of the “assets” that are
impossible to record on the balance sheet.
Intangible Assets
Types
Goodwill
Goodwill = Amount Paid for target – FMV of target’s assets.
Goodwill is only recorded when an entire business is purchased.
Considered to have an indefinite life. Not amortized.
(Note: this is a new rule based on SFAS 121, which is why
we are using the textbook supplement to Chapter 12.)
Intangible Assets
Amortization or Impairment?
FASB now considers some Intangibles to have
indefinite life (similar to land)
Indefinite Life Intangibles are no longer amortized.
They will only be written down if they become impaired.
e.g. Goodwill
Limited Life Intangibles are amortized over useful life.
e.g. Patents offer 20 year protection
Limited Life Intangibles may also be written down if
they become impaired.
Intangible Assets
Amortization
Limited Life
Amortize over:
1) Identifiable use pattern or
2) Straight-line over useful life
Indefinite Life
Don’t Amortize at all
Intangible Assets
Impairment
First, we need to determine when we need to test for impairment.
(Different rules for Limited Life vs. Indefinite Life assets)
Then, we need to determine if we need to record impairment.
(i.e., we need to run the impairment test)
(Different rules for Limited Life vs. Indefinite Life assets
vs. Goodwill)
Then, we need to determine how much impairment to record.
(i.e., we need to record the impairment loss)
(Same rules for Limited Life and Indefinite Life assets
but different rules for Goodwill)
Intangible Assets
Impairment
When do we need to run the Impairment Test?
Limited Life Assets:
Review for Impairment when any event or circumstance
indicates that the carrying or book value of the assets may
no longer be recoverable.
In other words, run the test when something happens
that makes you think an intangible asset may have lost
some value.
Example: Paterno Pharmaceutical Corp. should review for
impairment the value of its patent for the drug
HormoneRep, after learning of a study that links hormone
replacement therapy drugs to cancer.
Intangible Assets
Impairment
When do we need to run the Impairment Test?
Indefinite Life Assets:
Review for Impairment annually.
Intangible Assets
Impairment
Run the Impairment Test: Do we need to record an impairment loss?
Limited Life Assets:
(The Recoverability Test)
If Book Value > Undiscounted expected future cash flows
from use and disposition of asset
or…
(The FMV Test)
If Book Value > Fair Market Value
…then record impairment loss.
Intangible Assets
Impairment
Run the Impairment Test: Do we need to record an impairment loss?
Indefinite Life Assets (not including Goodwill):
(The FMV Test)
If Fair Market Value < Book Value
…then record impairment loss.
Intangible Assets
Impairment
Run the Impairment Test: Do we need to record an impairment loss?
Goodwill:
(The Subsidiary Value Test)
If Fair Market Value of the Subsidiary < Book
Value of the Subsidiary’s assets including
Goodwill
…then record impairment loss.
Intangible Assets
Impairment
If we need to record an impairment loss, how much should it be?
Limited or Indefinite Life Assets (not including Goodwill):
Impairment Loss = Carrying Amount - FMV
Intangible Assets
Impairment
If we need to record an impairment loss, how much should it be?
Goodwill:
The impairment loss will readjust the current Goodwill
balance to a new ending balance.
The new ending balance approximates what a buyer
would record as Goodwill if they bought the Subsidiary
today.
New ending balance = FMV of subsidiary – BV of
subsidiary’s assets excluding goodwill
Impairment Loss = GW Beg. Bal. –
GW End Bal.
(The loss readjusts the GW account balance)
Think of this as FMV
subsidiary – BV of
subsidiary’s “real” assets
Intangible Assets
Impairment Summary
1
Limited Life
Intangibles
Indef. Life
Intangibles
(Not Goodwill)
Goodwill
Test When?
Event indicates
possible
impairment
Annually
Annually
Impairment Test
1) Recoverability1
2) FMV2
FMV
Subsidiary Value3
Compute
Impairment Loss
Carrying Value –
FMV
Carrying Value –
FMV
GW Beg. Bal. –
GW End Bal4
Recoverability Test: BV > Net Future Cash Flows (Not Discounted)
2 FMV Test: BV > FMV
3 Subsidiary Value: Subsidiary BV of assets including GW > FMV of subsidiary
4 GW End. Bal: FMV of subsidiary – Carrying Value of Subsidiary assets
excluding Goodwill
Intangible Assets
Impairment Example—Limited Life Asset
Patent to extract oil recorded at $60,000,000
Can obtain $20,000,000 from selling patent (FMV of Patent)
Expected future cash flows from patent are $15,000,000
Recoverability Test:
Carrying Value > Expected future cash flows (undiscounted)
$60,000,000 > $20,000,000 + $15,000,000
Must record impairment loss = Carrying Value - FMV
= $60,000,000 - $20,000,000
Impairment Loss $40,000,000
Oil Patent
$40,000,000
Intangible Assets
Impairment Example—Indefinite Life Asset
Trademark recorded at $15,000,000
Can obtain $12,000,000 from selling trademark (FMV)
Expected future cash flows from patent are $900,000,000
FMV Test:
Carrying Value > FMV
Note: This is why the Recoverability
Test does not apply. Indefinite assets
may have incredibly large (even
infinite) future cash flows.
$15,000,000 > $12,000,000
Must record impairment loss = Carrying Value - FMV
= $15,000,000 - $12,000,000
Impairment Loss $3,000,000
Trademark
$3,000,000
Intangible Assets
Impairment Example—Goodwill
Paterno Inc. acquired Linebacker Co. 3 years ago:
FMV of Linebacker Assets:
FMV of Linebacker Liabilities:
Cash Paid by Paterno:
1,200,000
(300,000)
$1,100,000
$900,000 FMV
of net assets
After this transaction. Linebacker shows up on Paterno’s balance
sheet as a subsidiary as follows:
Linebacker Net Assets:
Assets
1,200,000
Goodwill
200,000
Liabilities
(300,000)
Net Assets
1,100,000
Paterno paid $1,100,000 for
$900,000 worth of net assets.
Intangible Assets
Impairment Example—Goodwill
Linebacker Net Assets:
Assets
1,200,000
Goodwill
200,000
Liabilities
(300,000)
Net Assets
1,100,000
During annual impairment review, the FMV of Linebacker is
determined to be $980,000
Subsidiary Value Test: FMV < BV of subsidiary assets including GW
$980,000 < $1,100,000. Need to impair.
Ending Goodwill Balance = FMV – BV of subsidiary assets excluding GW
Ending GW = $980,000 – (1,100,000 – 200,000) = $80,000
Impairment Loss = Adjustment to Goodwill Account = Beg Bal – End Bal
Impairment Loss = $200,000 - $80,000 = $120,000
Homework Hint (Preview of Ch. 23)
Any changes in amortization or depreciation are applied
to remaining book value in future years.
Example 1: Patent bought 2 years ago cost $400,000.
Useful life at purchase date 10 years. Revised useful life
Note: this includes the 2 you’ve already had.
estimate is 6 years.
Accumulated Depreciation (based on original estimates):
2 years x $40,000 per year = $80,000
Remaining BV = $400,000 - $80,000 = $320,000
Amortize this over the remaining useful life = 4 years.
$320,000 / 4 years = $80,000 per year from now forward.
Homework Hint (Preview of Ch. 23)
Any changes in amortization or depreciation are applied
to remaining book value in future years.
Example 2: Patent bought in 2000 cost $400,000. Useful
life of 10 years. On Dec 31, 2002, paid $16,000 legal fees
to defend patent rights.
Dec 31, 2002 Accumulated Depreciation (based on original estimates):
2 years x $40,000 per year = $80,000
Remaining BV = $320,000 + new legal fees = $336,000
Amortize this over the remaining useful life = 8 years.
$336,000 / 8 years = $42,000 per year from now forward.