Intermediate Accounting, 10th Edition

Kieso, Weygandt, and Warfield

Chapter 12: Intangible Assets

Prepared by
Krishnan Ranganathan, Angelo State University,
San Angelo, Texas

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 Part I: Intangible Assets -
Characteristics, Valuation, and
Amortization

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 Intangibles: Characteristics
 They lack physical existence
 They represent entity’s rights and privileges
 They are not financial instruments, such as
deposits or bank accounts
 They are long term in nature
 They are subject to amortization
 Examples are: patents and copyrights

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 Classification of Intangibles
Intangibles are either grouped or separately
identified based on the following factors:
 Are the assets developed internally, or
acquired singly or in groups?
 Is the expected benefit from the asset
limited or indefinite?
 Are the rights transferable or are they a
substantial part of the business?
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 Valuation of Intangible Assets
Intangibles

Internally-
Purchased
Created

Specifically Goodwill- Specifically Goodwill-

Identifiable type assets Identifiable type assets
Expense,
Capitalize Capitalize except direct Expense
costs
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 Amortization of Intangible Assets
 Intangibles are written off over their useful lives,
where the assets have determinable useful lives
 Where the intangibles have indeterminable useful
lives, they must be written off over a period not
exceeding 40 years
 Acquired intangibles should not be written off at
acquisition
 Intangibles are amortized on a straight-line basis for
tax purposes

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 Part 2:
Specifically Identifiable Intangibles

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 Specific Intangibles: Types
 Patents (product patents and process patents)
 Copyrights (relating to creations of authors,
painters, musicians and artists)
 Trademarks and Trade Names
 Leaseholds (Lease Prepayments, Leasehold
Improvements and Capital Leases)
 Franchises and Licenses

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 Patents (product patents and process
patents)

 A patent gives an exclusive right to the holder for

20 years.
 Costs of purchasing patents are capitalized
 Costs to research and develop patents are
expensed as incurred
 Patents are amortized over the shorter of the legal
life (20 years) or their useful lives
 Legal fees incurred to defend patents are
capitalized.

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 Copyrights
 Copyrights are granted for life of the creator plus
50 years
 Copyrights can be sold or assigned, but can not be
renewed
 Copyrights are amortized over their useful life
(not to exceed 40 years)
 Costs of acquiring copyrights are capitalized
 Research and development costs involved are
expenses as incurred

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 Trademarks and Trade Names
 Trademarks and Trade names are renewable
indefinitely by the original user in periods of 20 years
each
 For accounting purposes, trademarks and trade names
are amortized over periods not exceeding 40 years
 Costs of acquired trademarks or trade names are
capitalized
 If trademarks or trade names are developed by the
business, all direct costs (except R&D costs) are
capitalized.

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 Leaseholds
A leasehold is a contractual agreement
between:
 the lessor (owner) and the lessee (renter)
 giving the lessee the right to use the
property
 for a specific period of time
 in return for stipulated, periodic cash
payments
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 Leaseholds
 Lease prepayments are to be shown as prepaid
expenses, not as intangible assets
 Leasehold improvements (made by the lessee)
revert to the lessor at end of lease term
 Leasehold improvements are amortized over the
shorter of the remaining term of the lease or
useful life of the improvements
 Leasehold improvements are generally shown in the
(tangible) property, plant, and equipment section.

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 Leases (Capital Leases)
 If the lease agreement transfers all benefits and
risks, the lease is classified as a capital lease.
 The lease is shown as a tangible asset (at the
capitalizable cost) rather than as an intangible
asset

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 Franchises and Licenses
 A franchise is a contractual agreement under which:
 the franchisor grants the franchisee
 the right to sell certain products or services,
 to use certain trademarks or trade names, or
 to perform certain functions,
 within a certain geographical area

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 Franchises and Licenses
 A franchise may be for a limited time or for an
indefinite time period
 The cost of a franchise (for a limited time) is
amortized over the franchise term
 A franchise (for an unlimited time) is amortized
over a period not exceeding 40 years
 If a franchise is deemed worthless, the cost must be
written off immediately
 Annual payments for a franchise are expensed.

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 Part 3:
Goodwill

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 Goodwill
 Goodwill is the most intangible of all assets
 Goodwill can be sold only with the business
 Goodwill is the excess of:
the cost (purchase price) over
the amounts (price) assigned to tangible
and intangible net assets

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 Acquired Goodwill: Valuation

 Given:
Purchase price (cash): $ 100,000
Book value of assets: $ 88,000
Liabilities: $ 20,000
Market value of assets: $ 102,000
 Determine goodwill, if any

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 Acquired Goodwill - Computation

 Goodwill = Purchase Price - Fair value of net

assets
 $100,000 less $82,000 = $18,000
 Entry in the books of the Purchaser:
Assets $102,000
Goodwill $ 18,000
Liabilities $ 20,000
Cash $100,000
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 The Excess Earnings Approach

Capitalizes Excess Earnings of Seller

Steps:
 Compute Excess Earnings:
– Average Earnings less Industry Earnings
– Exclude all extraordinary gains and losses
 Capitalize excess earnings:
– [excess earnings / DISCOUNT FACTOR %]
– method is based on the assumption of perpetuity

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 The Excess Earnings Approach: Example

 Given the following information regarding Tractor

corporation, determine goodwill, if any:
 Net Identifiable assets: $ 500,000
 Normal rate of return: 20%
 Earnings history (1997 - 2001):

1997: $ 100,000 1998: $ 130,000

1999: $ 120,000 2000: $ 140,000
2001: $ 150,000
 Discount rate (proxies for risk): 15%
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 The Excess Earnings Approach: Example

 Average earnings: $ 640,000 / 5 = $128,000

 Normal return = $ 500,000 * 20%
= $ 100,000
 Excess earnings = $ 28,000
 Goodwill = $ 28,000 / 0.15
= $ 186,667

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 NEGATIVE Goodwill: Examples

 B/V FMV
 Current Assets 100,000 80,000
 Land 100,000 70,000
 Buildings 50,000 10,000
 TOTAL 250,000 160,000
 Liabilities -50,000 -50,000
 Net Assets 200,000 110,000

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 NEGATIVE GOODWILL
Case 1 Case 2 Case 3
FMV:NA 110,000 110,000 110,000
BV: NA 200,000 200,000 200,000
PRICE 110,000 150,000 86,000
G/WILL -0- 40,000 [24,000]
NA = Net Assets
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 Research and Development Costs

 Research activities involve:

 planned search or
 critical investigation
 aimed at discovery of new knowledge
 Example:
 Laboratory research aimed at discovery of
new knowledge

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 Research and Development Costs

 Development activities include:

 translation of research findings or other
knowledge
into a plan or design
for a new product or process, or
 significant improvement
to an existing product or process
whether intended for sale or for use

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 Research and Development Costs

 R & D costs involve searching for new products and

processes
 R & D costs are expensed unless the costs have
alternative future uses: (examples)
– Lab costs aimed at new knowledge
– Conceptual formulation of possible product
 Non R & D costs are expensed, if future benefits
are uncertain

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 Copyright

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