Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College 2

C H A P T E R 13 Intangible Assets

Learning Objectives 1. Describe the characteristics of intangible assets. 2. Discuss the recognition and measurement issues of acquiring intangibles. 3. Explain how specifically identifiable intangibles are valued subsequent to acquisition. 4. Identify the types of specifically identifiable intangible assets. 5. Explain the conceptual issues related to goodwill.

Learning Objectives 6. Describe the accounting procedures for recording goodwill at acquisition and subsequently. 7. Differentiate between research and development expenditures and describe and explain the rationale for the accounting for each. 8. Identify other examples of deferred charges and the accounting requirements for them. 9. Identify the disclosure requirements for intangibles, including deferred charges.

Intangible Assets Intangible Asset Issues Characteristics Current standards Recognition and measurement at acquisition Valuation after acquisition Specifically Identifiable Intangibles Patents Copyrights Trademarks Leaseholds Franchises Goodwill Recognition Negative Goodwill Valuation after acquisition Impairment Intellectual Capital Deferred Charges and Long-term Prepayments Research and development costs Pre-operating costs Initial operating losses Organization costs Advertising costs Conceptual questions Financial Statement Disclosure and Presentation Balance Sheet Income Statement Illustrative disclosures

Intangibles: Characteristics CICA Handbook, Section 3062, broadly defines intangible assets as: lacking physical existence non-financial assets Characteristics include: identifiability manner of acquisition expected period of benefit separability from an entire enterprise

Recognition and Measurement Purchased Intangibles Measured at cost – fair value at acquisition Cost follows same definition as with tangible capital assets Purchase of identifiable intangibles is generally straightforward Value is more easily determined Business combinations leads to goodwill Goodwill: (as an example) does not generate easily identifiable cash flows is not readily separable from the business entity control does not lead to contractual or legal rights Value (cost) of goodwill becomes a residual amount

Recognition and Measurement Goodwill should be accounted for and reported separately from other intangibles Identifiable intangibles with similar characteristics should be grouped and reported together Subsequent costs (betterments) are capitalized

Valuation of Intangible Assets Intangibles Purchased Internally- Created Specifically Identifiable Goodwill- type assets Capitalize Deferred Charges Restricted Amounts Specifically Identifiable Expense, except direct costs Goodwill type assets Expense

Valuation after Acquisition Intangibles are written-off over their useful lives, where the assets have determinable useful lives, not exceeding 40 years Where the intangibles have indeterminable useful lives, they must be written-off over a period not exceeding 40 years If the intangibles have an indefinite infinite life, the asset remains in the accounts unless it becomes impaired or its life becomes finite Intangibles are considered to have no residual (salvage) value

Valuation after Acquisition Factors to consider when determining economic useful life of an intangible: Expected future usage Effects of technological or commercial obsolescence Level of maintenance expenditures required to obtain future benefits Method of amortization should be chosen to match the benefits received, otherwise, straight-line amortization is used

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

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 Normally amortized over 17 years First 3 years required to process a patent application

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

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

Leaseholds A leasehold is a contractual agreement Details: agreement between the lessor (owner) and the lessee (renter) gives the lessee the right to use the property valid for a specific period of time in return for stipulated, periodic cash payments

Leaseholds and Leasehold Improvements 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

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

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

Franchises and Licenses A franchise may exist 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

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

Acquired Goodwill: Valuation Given: Purchase price (cash): $ 400,000 Book value of assets: $ 255,000 Liabilities: $ 55,000 Market value of assets: $ 350,000 Determine goodwill.

Acquired Goodwill: Calculation Goodwill = Purchase Price - Fair value of net assets $400,000 less 350,000 = $50,000 Entry in the books of the Purchaser: Assets (various) 405,000 Goodwill 50,000 Liabilities 55,000 Cash 400,000

Negative Goodwill “Badwill” or bargain purchase Fair value of acquired assets is greater than the purchase price CICA Handbook, Section 1581 Excess is used to reduce the amounts assigned to the other acquired assets, except for: financial assets (other than equity method investments) assets to be sold future tax assets prepaid assets that relate to employee future benefit plans If any excess remains after such assignment, remainder treated as an extraordinary gain

Intellectual Capital Also known as knowledge assets Include (among others), the following: Value of key personnel Organization adaptability Customer retention Strategic direction Conceptually cannot be reported as assets as the company does not have control They do, however, create long-term value (and benefit) to the company

Deferred Charges and Long-term Prepayments Research and Development Costs (R&D) Pre-operating and start-up costs Organization costs CICA Handbook, Section 3070 requires separate disclosure of deferred charges and their amortization amounts

Research and Development (R&D) Costs R&D costs not in themselves intangible assets They are generally material in amount, and lead to something that will be patented or copyrighted They therefore warrant special consideration Challenges in R&D accounting: Determining the costs associated with a particular activity or project Determining the size of future benefits, and for how long those benefits may be realized CICA Handbook, Section 3450 governs the accounting of R&D costs All research costs charged to expense when incurred Development costs are charged to expense except in certain defined circumstances

Research and Development (R&D) Costs Research activities: involve planned search or critical investigation aimed at discovery of new knowledge may or may not be directed towards a specific project Development activities include: translation of research findings or other knowledge into a plan or design for a new product or process significant improvement to an existing product or process

Research and Development (R&D) Costs R&D costs include the following: Direct materials and direct labour Amortization of tangible and intangible assets used/related to R&D activities Reasonable overhead allocation R&D costs are expensed Development costs are capitalized when all five of the following conditions are met and future benefits are reasonably certain

Research and Development (R&D) Costs Development cost capitalization criteria: 1. Product/process clearly defined, and costs can be identified 2. Technical feasibility has been established 3. Management intent to produce and market or use the product/process 4. If the intent is to sell, a market is clearly defined. If the intent is to use, there is a definable use/need 5. Resources exist to complete the project

Pre-operating Costs Costs incurred prior to formal operations beginning EIC-27 allows for the deferral of pre-operating costs if three conditions are met: 1. The expenditure relates directly to the business 2. It would not have been incurred if not for the business 3. The amount is likely to be recovered from future operations

Financial Statement Disclosure and Presentation Balance Sheet Goodwill must be reported as a separate line item Income Statement Amortization methods and rates are disclosed Goodwill impairment loss is reported separately

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