Applied Auditing

Audit of Intangibles
PROBLEM NO. 1

Transactions during 2005 of the newly organized Pink Corporation included the following:
Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to complete organization of the corporation.

15 Hired a clown to stand in front of the corporate office for 2 weeks and hound out pamphlets and candy to create
goodwill for the new enterprise. Clown cost, P10,000; pamphlets and candy, P5,000.

Apr.1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P 429,000
Patent application and licensing fees 63,500
Total P 492,500

It is estimated that in 6 years other companies will have developed improved processes, making the Pink
Corporation process obsolete.

May 1 Acquired both a license to use a special type of container and a distinctive trademark to be printed on the
container in exchange for 6,000 shares of Pinks no-par common stock selling for P50 per share. The license is
worth twice as much as the trademark, both of which may be used for 6 years.

July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be developed in future
research projects.

Dec. 31 Incurred salaries for an engineer and chemist involved in product development totaling P1,750,000 in 2005.
QUESTIONS:

Based on the above and the result of your audit, determine the following:
1. Cost of patent
2. Cost of licenses
3. Cost of trademark
4. Carrying amount of Intangible Assets
5. Total amount resulting from the foregoing transactions that should be expensed when incurred

PROBLEM NO. 2

On December 31, 2004, Silver Corporation acquired the following three intangible assets:

A trademark for P300,000. The trademark has 7 years remaining legal life. It is anticipated that the trademark will be renewed
in the future, indefinitely, without problem.

Goodwill for P1,500,000. The goodwill is associated with Silvers Hayo Manufacturing reporting unit.

A customer list for P220,000. By contract, Silver has exclusive use of the list for 5 years. Because of market conditions, it is
expected that the list will have economic value for just 3 years.

On December 31, 2005, before any adjusting entries for the year were made, the following information was assembled about each
of the intangible assets:

a) Because of a decline in the economy, the trademark is now expected to generate cash flows of just P10,000 per year. The useful
life of trademark still extends beyond the foreseeable horizon.

b) The cash flows expected to be generated by the Hayo Manufacturing reporting unit is P250,000 per year for the next 22 years.
Book values and fair values of the assets and liabilities of the Hayo Manufacturing reporting unit are as follows:

Book values Fair values

Identifiable assets P2,700,000 P3,000,000
Goodwill 1,500,000 ?
Liabilities 1,800,000 1,800,000
c) The cash flows expected to be generated by the customer list are P120,000 in 2006 and P80,000 in 2007.

REQUIRED:
Based on the above and the result of your audit, determine the following: (Assume that the appropriate discount rate for all items is
6%):
1. Total amortization for the year 2005
2. Impairment loss for the year 2005
3. Carrying value of Trademark as of December 31, 2005
4. Carrying value of Goodwill as of December 31, 2005
5. Carrying value of Customer list as of December 31, 2005

PROBLEM 3
The following independent situations relate to the audit of intangible assets. Answer the questions at the end of each situation.

a. YOLING INDUSTRIES reports the following patents on its December 31, 2012 statement of financial position.
Initial cost Date of acquisition Useful life
(at date of acquisition)
Patent A P1,224,000 March 1, 2009 17 years
Patent B 450,000 July 1, 2010 10 years
Patent C 432,000 Sept. 1 2011 4 years
Applied Auditing
Audit of Intangibles
The following events occurred during the year ended December 31, 2013.
Research and development costs of P737,100 were incurred during the year. These costs were incurred priorto projects
achieving economic viability.
Patent D was purchased on July 1 for P855,000. It has a remaining life of 9 years.
A possible impairment of Patent Bs value may have occurred at December 31, 2013. This is due to a significant
reduction in the demands for certain products protected by Patent B. the companys controller estimates the following
future cash flows from Patent B.
December 31, 2014 P60,000
December 31, 2015 60,000
December 31, 2016 60,000

The appropriate discount rate to be used for these cash flows is 8%.

1. What is the total carrying value of Yolings patents on December 31, 2012?
2. What amount of impairment loss should be reported by Yoling for the year ended December 31, 2013?
3. What is the total value of Yolings patents on December 31, 2013?

b. In your audit of the books of MELANIE CORP. for the year ended December 31, 2013, you found the following items in
connection with the companys patents account.
Melanie had spent P360,000 during the year ended December 31, 2012, for research and development costs. This amount
was debited to its patents account. The companys cost records discloses that it had spent a total of P424,500 for the
research and development of its patents, of which P64,500 spent in 2012 had been debited to Research and Development
Expenses.
The patents were issued on July 1, 2012. In connection with the issuance of the patents, the company incurred legal
expenses of P42,840, which are debited to Legal and Professional Fees Expense.
On January 5, 2013, Melanie paid a retainer of P45,000 for legal services in connection with a patent infringement suit
brought against it. Deferred Costs was charged for the amount.
In reply to your inquiry about the companys liabilities as of December 31, 2013, you received a letter from the companys
legal counsel dated January 20, 2014, which indicated that a settlement of the patent infringement suit had been
arranged. The plaintiff will drop the suit and release the company from all future liabilities in exchange for P60,000.
Additional lawyers fees were incurred amounting to P3,780.

4. The correcting journal entries (excluding amortization) on December 31, 2013 would be......

c. As the recently appointed auditor of SUBHUMAN COMPANY, you have been asked to examine selected accounts. You audit client,
organized in 2012, has setup a single account for all intangible assets. The following summary shows the debit entries that have
been recorded during 2013.
January 2 Purchased patent (8-year life) P870,000
April 5 Goodwill 720,000
June 30 Payment of 12 months rent on property leased by Subhuman 182,000
July 1 Purchased franchise with a 10-year life:
expiration date, July 1, 2023 900,000
August 3 Payment for copyright (5-year life) 312,000
September 1 Research and development costs related to patent
(incurred prior to achieving economic viability) 320,000
P3,304,000

5. What is the total carrying value of Subhumans intangible assets as of December 31, 2013?

PROBLEM 4
1. There is goodwill involved in the acquisition of a business if the purchase price paid is in excess of the proprietorship of the
business acquired.

Goodwill might be viewed as the enjoyment of a profit by a company in excess of the normal or usual return for the industry
as a whole but such goodwill is not recorded if it has not been purchased or paid for.
a. False; True. c. True; False.
b. False; False. d. True; True.

2. In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether the
amortization period is reasonable in support of managements financial statement assertion of
a. Valuation. c. Completeness.
b. Existence or occurrence. d. Rights and obligations.