Administrative Quiz 4 due today Project 3 due Monday 3/2 Final Exam – Section 1 (10:15 – 12:05) Wednesday 3/18 at 10:15 Section 2 (5:30) Monday, 3/16 at 5:30 Chapters 10, 11, 12 Today Wrap up ch. 11 Ch. 12 Intangible Assets Agenda

Lack physical existence Represent entity’s rights and privileges Not financial instruments Long term in nature Intangibles: Characteristics

Intangibles are written off over their useful lives, where the assets have determinable (finite) useful lives. Where the intangibles have indefinite useful lives, they are not amortized Amortization of Intangible Assets

Marketing-related (i.e., trademark, trade name) Customer-related (i.e., customer lists, customer relationships) Artistic-related (i.e., copyrights) Contract-related (i.e., franchise, licenses or permits). Technology-related (i.e., product patent, process patent) Goodwill Specific Intangibles: Types

Trademarks and trade names are renewable indefinitely by the original user in periods of 10 years each. Costs of acquired trademarks or trade names are capitalized. If trademarks or trade names are developed by a business, all direct costs (except R&D costs) are capitalized. Marketing-Related Intangibles: Trademarks and Trade Names

Include: customer lists order or production backlogs customer relationships Amortized over useful life Customer-Related Intangibles

Copyrights are granted for life of the creator plus 70 years. Copyrights can be sold or assigned, but cannot be renewed. Copyrights are amortized over their useful life. Costs of acquiring copyrights are capitalized. Research and development costs involved are expensed as incurred. Artistic-Related Intangibles: Copyrights

A franchise is a contractual agreement under which the franchisor grants the franchisee: the right to sell certain products or services, the right to use certain trademarks or trade names, or the right to perform certain functions, within a certain geographical area. 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 carried at cost and not amortized. Annual payments for a franchise are expensed. Contract-Related Intangibles

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 successfully defend patents are capitalized. Technology-Related Intangibles: Patents

Goodwill can be sold only with the business – it is recognized only when an entire business is purchased. Internally created goodwill is not capitalized Goodwill is the excess of: the purchase price over the fair value of the tangible and intangible net assets acquired Goodwill has an indefinite life and should not be amortized but is subject to impairment Impairment test should be performed at least annually If applicable, an impairment loss is recorded Goodwill

Finite-life intangible assets: US GAAP reports at cost less accumulated amortization If an active market exists, IFRS allows reporting at fair value, less accumulated amortization and impairment Internally generated intangibles: US GAAP: R&D costs are generally expense as incurred IFRS: Costs are identified as belonging to the Research OR development phase Costs in the research phase are always expensed Costs in development phase are expensed unless the following met: Technical feasibility of completing the intangible asset Intention to complete the intangible asset Ability to use or sell it Generation of future economic benefits (existence of a market or internal usefulness of the asset) Adequate resources to complete the development Ability to reliably measure the expenses during development US GAAP vs. IFRS

Type of Asset Property, Plant & Equipment Limited Life Intangible Indefinite-life intangible, other than goodwill Impairment Tests Recoverability test, then fair value test Fair value test Impairment Tests

Is there Impairment to Intangible Assets?

On January 1, 2001, Nemo, Inc. acquired a patent. The patent has an estimated useful life of 20 years. Presented below is information related to the patent at December 31, 2005: Acquisition cost: $500,000 Carrying amount: $375,000 Expected future cash flows: $350,000 Fair Value: $325,000 What is impairment loss, if any, at 12/31/05? Would answer change if expected future cash flows were $380,000? Intangible Impairment Example – Finite Life

On January 1, 2001, Nemo, Inc. acquired a trademark with an indefinite useful life. Presented below is information related to the trademark at December 31, 2005: Acquisition cost: $400,000 Carrying amount: $322,000 Expected future cash flows: $340,000 Fair Value: $315,000 What is impairment loss, if any, at 12/31/05? Intangible Impairment Example – Indefinite Life

On January 1, 2006, CSI Industries purchased all the outstanding shares of Grissom, Inc. for $200,000 At the time of purchase, Grissom, Inc. had the following assets and liabilities recorded on its balance sheet: Goodwill Example

Assume that Grissom developed a unique process for identifying DNA from blood samples and that the company owns a patent on this process. An independent appraisal determines the value of the patent to be $20,000. In addition, the appraisal determines that the fair value of the company’s inventory is $80,000, the fair value of its PPE is $150,000 and, because of a drop in interest rates, the market value of its notes payable is $120,000. Calculate the amount, if any, of goodwill that should be recorded.

Step 1: Compares fair value of reporting units to its carrying amount, including goodwill If FV of reporting unit > carrying amount, no impairment If FV of reporting unit < carrying amount, go to Step 2 Step 2 Determine fair value (implied value) of goodwill and compare to the goodwill carrying amount Implied value is equal to: Fair value of reporting unit - Net identifiable assets, excluding GW Goodwill Impairment Test: 2-Step Process

Goodwill Impairment Example

No Impairment example: Hornbuckle Corporation has 4 divisions: The Anderson Division has the following net assets: Cash 11,000 AR 120,000 PP&E 95,000 Goodwill 150,000 l: AP & NP (125,000) Net assets 251,000 FV of Anderson Division 325,000 Step 1: Compares fair value of reporting unit to its carrying amount, including goodwill If FV of reporting unit > carrying amount, no impairment So – don’t need to go to Step 2 – no impairment Goodwill Impairment Test: 2-Step Process Example

Impairment Example (Carrying amt = FV of net identifiable assets, excl. GW): Hornbuckle Corp. has 4 divisions. The B Division has the following net assets: Cash 11,000 AR 120,000 PP&E 95,000 Goodwill 150,000 l: AP & NP (125,000) Net assets 251,000 FV of B Division 200,000 Step 1: Compare FV of reporting unit to its carrying amount, including GW Here, FV of reporting unit < carrying amount, so go to Step 2 Step 2: Determine fair value (implied value) of goodwill and compare to the goodwill carrying amount. Here, assume that the carrying amount equals the FV of net identifiable assets (excluding goodwill) Implied value is: Fair value of reporting unit – Fair value of net identifiable assets, excluding goodwill: 200,000 – [251, ,000] = 99,000 Loss on impairment = GW carrying amount – GW implied value: 150,000 – 99,000 = 51,000 Goodwill Impairment Test: 2-Step Process Example

Impairment Example (Carrying amt ≠ FV of net identifiable assets, excl. GW): Hornbuckle Corp. has 4 divisions. The B Division has the following net assets: Cash 11,000 AR 120,000 PP&E 95,000 Goodwill 150,000 l: AP & NP (125,000) Net assets 251,000 FV of B Division 200,000 Step 1: Compare FV of reporting unit to its carrying amount, including GW Here, FV of reporting unit < carrying amount, so go to Step 2 Step 2: Determine fair value (implied value) of goodwill and compare to the goodwill carrying amount. Here, assume that the fair value of PP&E is 110,000 Implied value is: Fair value of reporting unit – Fair value of net identifiable assets, excluding goodwill: 200,000 – [266, ,000] = 84,000 Loss on impairment = GW carrying amount – GW implied value: 150,000 – 84,000 = 66,000 Goodwill Impairment Test: 2-Step Process Example

Reversals of impairment losses: US GAAP prohibits IFRS allows under special circumstances, except for goodwill Impairment assessment US GAAP: uses a 2-step process for finite life intangibles performs the impairment calculation at the reporting unit level (an operating segment, for which management reviews financial information) IFRS: uses a 1-step process for all intangibles performs the impairment calculation at the cash-generating unit level (“the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets”) US GAAP vs. IFRS

Contra accounts are not normally shown. On the balance sheet, all intangible assets should be reported as a separate item. On income statement, amortization expense and impairment losses should be presented as part of income from continuing operations. Unless goodwill impairment loss is associated with discontinued operations, it should also be reported as part of continuing operations. Presentation of Intangibles

R & D costs involve searching for new products and processes R & D costs are expensed unless the costs have alternative future uses Disclosure is required in the financial statements of the total R & D costs charged to expense each period for which an income statement is presented. Research and Development Costs