Chapter 12 Intangible Assets

ACCT373 Intermediate Accounting Otto Chang Professor of Accounting Chang, O.H.

1

Characteristics of Intangible Assets

• Intangible assets are characterized by lack of physical existence and high degree of uncertainty concerning the future benefits • General rules of accounting: – Purchased: recorded at cost, amortized over economic life of legal life whichever is shorter (but no more than 40 years in any case) – Internally developed: all costs expensed unless future benefits are very much ascertained – Contra-asset account is not generally used Chang, O.H.

2

Specifically Identifiable Intangibles

• Patents – Economic life: 17 years or shorter – Capitalizable costs: purchase price, registration fee, attorney fee, cost of a successful legal suit to defend the patent.

– Non-capitalizable: R&D expense • Copyrights – legal life (author’s life plus 50 years) or 40 years Chang, O.H.

3

• Trademarks and Trade Names – No definite legal life, so amortize over 40 years or less • Leaseholds: the right to lease a property – rents are capitalized if prepaid or under a capital lease • Leasehold Improvements – capitalize and amortize over the shorter of remaining lease term or economic life Chang, O.H.

4

• Organization costs – Fees to underwriters of stocks or bonds, attorney fees, state fees, promoter’s salaries etc.

– Generally amortize over 60 months • Development stage enterprises – Should be treated the same as regular enterprises – Operating losses in the start-up of a business should not be capitalized Chang, O.H.

5

Goodwill

• The excess of purchase price over FMV of identifiable assets purchased • Estimation of purchase price = Future annual earnings (adjusted for extraordinary items) / capitalization rate • Estimation of goodwill = Excess earning* / capitalization rate * Excess earning = Future annual earning - normal annual earning** **Normal earning = FMV of assets x expected rate of return Chang, O.H.

6

Accounting for Goodwill

• Recording Goodwill Assets acquired (revised to FMV) Goodwill Liabilities acquired (revised to FMV) Cash • Amortization of Goodwill over useful life – but no more than 40 years Chang, O.H.

7

Badwill

• Badwill = FMV of assets - purchase price • should be allocated to reduce proportionately the values assigned for non current assets.

• If the allocation reduces the non-current assets to zero, the remainder will be classified as deferred credit and amortized Chang, O.H.

8

Impairment of Intangible Assets

• Treatment similar to impairment of long lived assets • For specifically identifiable intangible assets (such as patents, copyrights etc.), write down the asset to its fair value • For goodwill-type intangibles, reduce any goodwill (or if no goodwill, the long-lived assets) by the amount of loss recognized Chang, O.H.

9

Accounting for R &D Activities

• General rule: expensed unless the assets are can be used in other future projects (e.g., acquisition of research facilities or equipment) or capitalizable as cost of patents • Reimbursed R&D expenses: Dr. A/R (= R&D costs) Cr. Cash or other credits Chang, O.H.

10

Accounting for Software Costs

• Developed for external sale: – Capitalize costs after technical feasibility has been established (upon completion of a detailed program design or working model) – Annual amortization = greater of S-L amortization or amortization in relation to % of revenues estimated for future years – Value at lower of cost or NRV on B/S • Developed for internal usage: – Expensed (FASB) or capitalized if future benefit is clearly evident (IMA) Chang, O.H.

11

Other Assets

• Sometimes referred to as

Deferred Charges

• A catch-all category for everything not belonging to other categories • Examples: – Property held for sale – Prepaid pension costs – Deferred income taxes Chang, O.H.

12