1. 1 Intangible assets

2. 2 Meaning of Intangible assets Intangible assets are assets which have no physical existence. They are long-lived non-material rights which may generate future revenues

3. 3 Example of intangible assets Goodwill Research and development expenditures Patents Copyrights Franchises Trademarks

4. 4 Problems in accounting for intangible assets Some intangible assets are self-developed. Their costs cannot be measured objectively and easily Some intangible assets such as goodwill do not have definite lives and they are not capable of being amortized over their indefine lives It is difficult to identify specific revenues arising from the use of intangibles

5. 5 Accounting for an intangible asset

6. 6 To record the cost of an intangible asset Dr. Intangible assets Cr. Bank

7. 7 An intangible asset should be recognized if it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; the cost of the asset can be measured reliably An intangible asset should be measured its initially at cost The cost of an intangible asset comprises its purchase price including all other expenditures on preparing the asset for its intended use such as import duties and professional fees for legal services. Any trade discount and rebates are deducted in arriving at the cost

8. 8 To write off the expenditure incurred from which no intangible asset can be created Dr. Profit and loss Cr. Bank

9. 9 With creating intangible assets, the following expenditures should be recognized as expenses when it is incurred: Expenditure on start-up activities which comprises establishing cost, pre-opening cost for new facility, new operation or business Expenditure on training activities, advertising and promotional activities and relocating or re- organizing part of all of an enterprises

10. 10 Expenditure on an intangible item that was initially recognized as an expense in previous annual financial statement or interim financial reports should not be recognized as part of the cost of an intangible asset at a later date

11. 11 To recognize the subsequent expenditure as an intangible asset Dr. Intangible assets Cr. Bank

12. 12 Subsequent expenditure can be capitalized if the expenditure will enable the asset to generate future economic benefits in excess of its original level; and the expenditure can be measured and attributed to the asset reliably

13. 13 To record the provision for amortization Dr. Profit and loss Cr. Accumulated amortization

14. 14 After initial recognition, an intangible asset should be carried at its cost less any accumulated amortization and and any accumulated impairment losses The intangible asset should be amortized on a systematic basis over its useful lives (not exceed 20 years or the period of legal right)

15. 15 To record the provision for impairment loss Dr. Profit and loss Dr. Accumulated amortization Cr. Intangible assets

16. 16 When the carrying amount (cost less accumulated amortization) exceeds the recoverable amount of an intangible asset, there is an impairment loss

17. 17 After revaluation To record revaluation surplus Dr. Intangible asset Dr. Accumulated amortization Cr. Revaluation reserve To record the reversal of previous impairment loss that was recognized as an expenses Dr. Intangible asset Dr. Accumulated amortization Cr. Profit and loss

18. 18 After initial recognition, an intangible asset should be carried at a revalued amount After revaluation, the intangible asset should be stated at its fair value less any subsequent amortization and any subsequent accumulated impairment losses

19. 19 Accounting for Goodwill

20. 20 Definition Goodwill is the difference between the value of a business as a whole and the aggregate of the fair value of its separable net assets Goodwill = Selling price as a going concern – Fair value of separable net assets = Selling price – ( Assets – Liabilities)

21. 21 Nature of Goodwill A business may be valued higher as a going concern, or a buyer may be willing to pay more for a business as a going concern than the total value of net assets because of the favourable attributes a firm owns. Some of advantages which may add to the value of a business as a going concern Good location Good customer relations Good reputation Well-known products Experienced and efficient employees and management team Good relation with suppliers

22. 22 Characteristics Is intrinsic to the business Is self-developed The value of goodwill may fluctuate widely according to internal and external circumstances The value of goodwill is subjective according to different valuers.

23. Why intrinsic? Its existence depends on the continuance of the business. It cannot be realized separately from the business as a whole. back

24. 24 Calculation of goodwill Subjective Judgement Average Sales/Fees/Profits Method Super Profit Method

25. 25 Subject Judgement Estimate the value of goodwill with reference to some intangible factors and according to their professional judgement

26. 26 Average Sales/Fees/Profit Method It can be calculated on gross average or weight average Goodwill = Average annual sales/fees/profits over a stated number of years * a factor The factor is usually stated as a certain number of years’ purchase of the average sales/fees/profits

27. 27 Example 1

28. 28 YearAnnual Sales $ 1995 100000 1996 200000 1997 300000 (a)Goodwill is valued at 3 years ’ purchase of the average annual sales of the past 3 years: Average annual sales = ($100000+200000+300000 ) /3 = $200000 Goodwill = $200000 X3 = $600000

29. 29 (b) Goodwill is valued at the 3 years ’ purchase of the weighted average of the annual sales of the past 3 years Weighted average annual sales = (100000 x 1 + 200000 x 2 + 300000 x 3) 1+2+3 = 1400000 6 = 233333 (Calculation to the nearest dollar)

30. 30 Super Profit Method A business with goodwill is expected to be able to earn more profit than a business without goodwill The extra profit earned is called the super profit Statement Calculating Super Profit Average annual net profitX Less: Reasonable remuneration to the owner X Reasonable return on the capital employed in the tangible assetsXX Super profitX

31. 31 Example 2

32. 32 Chan is leaving the partnership, and goodwill is to be revalued at 3 years’ purchase of the super profit. The expected rate of return on net tangible assets is 10 %, after paying a management fee of $500. The calculation of the super profit is to be based on the average profits of the last four years. Net profit from 1994-1997 is $5000, $6500, $6500, $7000 Expected return on net tangible assets = Net tangible assets * 10%. Expected return is $5000.

33. 33 Answer Statement Calculating Super Profit$ Average net profit (5000+6500+6500+7000)/46250 Less: Management fee500 Expected rate of return on net tangible assets50005500 Super profit750 Goodwill= $750 X 3 = $2250

34. 34 Different types of goodwill Inherent goodwill Purchased goodwill Negative goodwill

35. 35 Inherent goodwill

36. 36 Definition It is the goodwill developed by the business internally. Over a long period in a certain trade, the business has developed many good relations Therefore, the public estimates that the value of the business as a going concern is higher than the value of its net assets

37. 37 Accounting treatment Non-purchased goodwill should not be recognized in the financial statements

38. 38 Reasons supporting this argument It is an internally generated goodwill which cannot be attributed to separately intangible expenditures It is intrinsic to the business. It cannot be sold as a separate asset The value of non-purchased goodwill may fluctuate widely according to internal and external circumstances The valuation and verifiability of the existence of non-purchased goodwill are subjective

39. 39 Purchased goodwill

40. 40 Definition It arises when a business acquires another as a going concern It is the difference between the purchase consideration of the company acquired as a going concern and the fair value of its net assets

41. 41 Accounting treatments Purchased goodwill is recorded at cost less any accumulated amortization and any accumulated impairment losses

42. 42 To record the cost of goodwill Dr. Goodwill Cr. Business purchase

43. 43 Purchased goodwill should be measured initially at cost Reasons Money has been spent to acquire the goodwill, so it is difficult to argue that purchased goodwill is not an asset

44. 44 To record the provision for amortization Dr. Profit and loss Cr. Accumulated amortization

45. 45 After initial recognition, purchased goodwill should be carried at its cost less any accumulated amortization Purchased goodwill should be amortized on a systematic basis over its useful life (not exceed 20 years)

46. 46 To record the impairment loss Dr. Other assets Dr. Goodwill Cr. Profit and loss

47. 47 When the carrying amount (cost less accumulated amortization) exceeds the recoverable amount of an intangible asset, there is an impairment loss The impairment loss should be allocated firstly to the goodwill, and then the other assets proportional to the carrying amount of each asset

48. 48 Revaluation No entry

49. 49 There is no active market, hence goodwill should not be revaluated

50. 50 Negative goodwill Negative goodwill arises in a business acquisition when the fair market value of the net assets of the acquired company exceeds the purchase price paid It is an unrealized capital profit which should be credited to the reserves

51. 51 Negative goodwill arises when There is a bargain purchase due to a quick sale The purchase price has been reduced for the expected future cost or losses

52. 52 3 steps for accounting negative goodwill Ascertain the amount of the negative goodwill Identify future losses and expenses Remaining negative goodwill The amount of negative goodwill not exceeding the fair value of acquired identifiable non-monetary assets should be recognized as income on a systematic basis over the remaining weighted average useful life of the identifiable acquired depreciable/amortizable asset The amount of negative goodwill in excess of the fair value of acquired identifiable non-monetary assets should be recognized as income immediately

53. 53 Example

54. 54 On 1 January 2001, Big Ltd. acquired Small Ltd. for a purchase consideration of $200000. The fair value of the net assets of Small Ltd. at the date of acquisition was $440000 including: Tangible assets$100000 Intangible assets$20000 Cash$320000 $440000 The negative goodwill = $440000-$200000 = $240000 It is expected that Small Ltd. will incur a loss of $30000 Over the next two years

55. 55 3 steps for accounting negative goodwill are shown as follows: (a)Ascertain the amount of the negative goodwill 1 Jan 2001Dr. Business purchase$240000 Cr. Negative goodwill$240000 (b) Identify the negative goodwill of $30000 relating to future losses and expenses over the next two years 31 Dec 2001Dr. Negative goodwill$15000 Cr. Profit and loss$15000 31 Dec 2002Dr. Negative goodwill$15000 Cr. Profit and loss$15000 ( c) Remaining negative goodwill the first of $120000 will be released over the weighted average useful lives of tangible and intangible asset $90000 will be credited to P/L immediately

56. 56 Accounting for Goodwill in Partnership

57. 57 Accounting for goodwill in partnership Only purchased goodwill is to be brought into the accounts. In sole trader’s accounts, goodwill is to be recognized and recorded in the books only if the business is acquired as a going concern In partnerships, however, goodwill is brought into the books whenever there is a change in the partnership such as: Admission of a new partner Retirement of an old partner Change of the profit-sharing ratio

58. 58 Each partner has a share of the profit- sharing ratio. At a change in the partnership, goodwill must be taken into account and shared among the existing partners, according to the existing profit-sharing ratio

59. 59 Goodwill on the admission of a new partner

60. 60 Goodwill on the admission of a new partner The new partner is required to pay for his share of the tangible assets as well as the goodwill, according to the profit-sharing ratio On the admission of a new partner, goodwill must be revalued However, not all business keep a goodwill account in their books. Goodwill adjustments can be done: Goodwill account opened Goodwill account not opened

61. 61 Goodwill account opened The value of the goodwill will be credited to the old partners’ capital accounts, which represents an increase in the resources they own, while the new partner will not have a share of the goodwill Dr Goodwill account Cr Capital account ( old partners only With the value of goodwill With their share of goodwill in old ratio Dr Goodwill account Cr Capital account ( old partner With the increase in the value of goodwill, share in the old ratio Dr Capital account (old partner) Cr Goodwill account With the decrease in the value of goodwill, share in the old artio

62. 62 Goodwill account not opened Goodwill is intangible in nature. It cannot be disposed of separately. Therefore, some businesses prefer not to maintain a goodwill account The new partner may be required to pay extra cash, or have his capital balance reduced, for his share of goodwill Dr Goodwill account Cr Capital account (old partners only) Share goodwill among old partners in old profit-sharing ratio Dr Capital account ( all partners) Cr Goodwill account Written off goodwill among all partners in the new profit-sharing ratio

63. 63 Example 3

64. 64 Chan and Wong were partners sharing profits and losses equally. On 1 January 1998, they admitted Lee as a new partner who was required to introduce $600 as capital. The profits are now to be shared among Chan, Wong and Lee equally. Goodwill is valued at $300. The balance sheet before the admission of the new partner is shown as follows: Chan and Wong Balance Sheet as at 31 December 1997 Assets1,200Capital Chan600 Wong600 1,200

65. 65 Goodwill account opened Goodwill Capital: Chan (1/2)150 Wong (1/2)150 300 Capital ChanWong LeeChanWongLee Balance c/f 750 750 600 Goodwill 150 150 Cash 600 750 750 600 Balance c/f300 Balance b/f 600 600

66. 66 Goodwill account opened Balance Sheet as at 31 December 1998 Assets Goodwill 300 Capital Chan750 Other Assets (1,200 + 600) 1,800Wong750 Lee600 2,100 New capital balance

67. 67 Goodwill account not opened Capital ChanWong LeeChanWongLee Goodwill : new ratio 100 100 100 Goodwill: old ratio 150 150 Cash 600 750 750 600 Balance c/f 650 650 500 Balance b/f 600 600 Before admissionAfter admission PartnerOld ratioShare of goodwill New ratioShare of goodwill Gain/loss Chan1/2$1501/3$100$50 loss Wong1/2$1501/3$100$50 loss Lee1/3$100$100 gain $300

68. 68 Goodwill account not opened Balance Sheet as at 31 December 1998 AssetsCapital Chan650 Wong650 Lee500 1,800 Assets (1,200 + 600) 1,800

69. 69 Accounting for Research and Development Expenditures

70. 70 Definition Pure research An investigation undertaken in order to gain new scientific knowledge but not directed towards any specific aim or application Applied research An investigation undertaken in order to gain new scientific knowledge but directed towards any specific aim or application Development research The use of existing scientific or technical knowledge in order to produce new or improved products for the sake of commercial production or application

71. 71 Accounting treatment – research cost Pure and applied research Research costs should be written off as incurred The prudence concept requires the costs to be written off unless it is reasonably certain that sales will be made in the future which will fully cover those costs

72. 72 Accounting treatment – development cost Development expenditures Development expenditures should be written off as incurred Development expenditures can be deferred to future periods and recorded as an asset OR

73. 73 Development expenditures can be deferred to future periods and recorded as an asset,when the following conditions are satisfied: The project is clearly defined The expenditures are identified separately There is reasonable certainty about the outcome of the project The deferred development expenditures are expected to be recover from related future sales or other revenues The business has adequate resources to complete the project

74. 74 Deferred development expenditures should be amortized on a systematic basis over the period in which the product is sold. The amortization starts in the year that commercial production starts When there is any doubt about the certainty of the future revenue, the unamortized amount of deferred expenditures must be written off immediately Reinstatement of previously written-down deferred expenditure should be credited to P/L

75. 75 Reversal of impairment loss is rstricted to the amount that would restore the carrying amount as if no impairment loss has been recognized Any fixed assets acquired for development activities should be capitalized and depreciated over their useful lives

76. 76 Accounting for Trademark

77. 77 Definition A trademark is the legal protection afforded the names, symbols, and other specific identities assigned to a product

78. 78 Valuation of trademark The costs capitalized include design, registration and the legal cost of successfully defending the trademark in court

79. 79 Accounting for trademark A trademark is deferred and amortized as an expense over the shorter if the legal life or economic life It is generally considered to have no limited term of existence or natural limited life. However, the legal protection of a trademark is subject to renewal after a number of years

80. 80 Accounting for Patent

81. 81 Definition A patent is an exclusive right to use, manufacture, process, or sell a product granted by the government

82. 82 The valuation of patent Patent can be purchased from the inventor or holder, or they can be generated internally When a patent is purchased from the inventor, the cost capitalized include the acquisition cost, legal cost and the legal costs of successfully defending a patent in court It a patent results from successful research and development efforts, the costs capitalized include only the legal costs such as registration fees and attorney fees, incurred in obtaining the patent

83. 83 Accounting treatment The research and development costs spent to develop the patent must be written off to expenses as they are incurred A patent should be amortized over its remaining legal life or economic life, whichever is shorter It the patent is lost in court, it should be written off and shown as an exceptional loss

84. 84 Accounting for Copyright

85. 85 Definition A copyright is the exclusive rights of the creator or heirs to reproduce or sell an artistic or published work

86. 86 Valuation of copyright It is recorded at its acquisition price

87. 87 Accounting treatment A copyright should be amortized over the shorter of its economic or legal life

88. 88 Accounting for franchise A franchise is an exclusive rights granted to a franchise permitting him to operate using the franchiser’s name

89. 89 Valuation of franchise The franchise must pay a franchise fee for such rights

90. 90 Accounting treatment A franchise should be amortized over its economic life