Intangible Assets
I.
Overview, Valuation, and Characteristics of Intangible Assets – The term “intangible
assets” refers to certain long-lived legal rights and competitive advantages developed or
acquired by a business enterprise. They are typically acquired to be used in operations of
a business and provide benefits over several accounting periods. Intangible assets differ
considerably in their characteristics, useful lives, and relationship to operations of an
enterprise and are classified accordingly.
a. Classification of Intangible Assets
i. Identifiability
1. Intangible assets may be either specifically identifiable (patents,
copyrights, franchise, etc.) or not specifically identifiable
(goodwill).
2. Patents, copyrights, franchises, trademarks, and goodwill are the
common intangible assets tested on the CPA exam.
ii. Manner of Acquisition
1. Purchased Intangible Assets – intangible assets acquired from
other enterprises or individuals should be recorded at cost. Legal
and registration fees incurred to obtain an intangible asset should
also be capitalized.
2. Internally Developed Intangible Assets
a. The cost of intangible assets not acquired from others
(developed internally) and not specifically identifiable (or
having indeterminate lives) should be expensed against
income when incurred.
b. Examples
i. Trademarks (except for the capitalizable costs
identified below)
ii. Goodwill from advertising
iii. The cost of developing, maintaining, or restoring
goodwill
c. The exception is that certain costs associated with
intangibles that are specifically identifiable can be
capitalized, such as:
i. Legal fees and other costs related to a successful
defense of the asset, registration or consulting fees,
design costs, and other direct cots to secure the
asset.
d. Expected Period of Benefit – Classification of the
intangible asset depends upon whether the economic life
can be determined or is indeterminable.
e. Separability – The classification of the intangible asset
depends upon whether the asset can be separated from the
entity (a patent) or is substantially inseperable from it (a
trade name or goodwill).
f. GAAP vs. IFRS: Under IFRS, research costs related to an
internally developed intangible asset must be expensed, but
an intangible asset arising from development is recognized
if the entity can demonstrate all of the following:
i. Technological feasibility has been established.
ii. The entity intends to complete the intangible asset.
iii. The entity has the ability to use or sell the intangible
asset.
iv. The intangible asset will generate future economic
benefits.
v. Adequate resources are available to complete the
development and sell or use the asset.
vi. The entity can reliably measure the expenditure
attributable to the development of the intangible
asset.
b. Capitalization of Costs – A company should record as assets the cost of intangible
assets acquired from other enterprises or individuals.
i. Cost is measured by the amount of cash disbursed or the fair value of other
assets distributed, the present value of amounts to be paid for liabilities
incurred, and the fair value of consideration received for stock issued.
ii. Cost may be determined either by the fair value of the consideration given
or by the fair value of the property acquired, whichever is more clearly
evident.
iii. The cost of unidentifiable intangible assets is measured as the difference
between the cost of the group of assets or enterprise acquired and the sum
of the costs assigned to identifiable assets acquired, less liabilities
assumed.
iv. The cost of identifiable assets should not include goodwill.
c. Expensing of Cost – Costs of developing, maintaining, or restoring intangible
assets that are not specifically identifiable, have indeterminate lives, or are
inherent in a continuing business and related to an enterprise as a whole
(goodwill) should be deducted from income when incurred.
i. Expenses that increase the useful life of the intangible asset will require an
adjustment to the calculation of the annual amortization.
II.
Amortization – The value of intangible assets eventually disappears; therefore, the cost
of each type of intangible asset (except for goodwill) should be amortized by systematic
charges to income over the period estimated to be benefited. Candidates should be aware
a patent is amortized over the shorter of its esimated life or remaining legal life.
a. Method – The straight-line method of amortization should be applied unless a
company demonstrates that another systematic method is more appropriate. The
method and estimated useful lives of intangible assets should be adequately
disclosed in the notes to the financial statements.
b. Goodwill (Impairment Approach) – Amortization of purchased goodwill is no
longer permitted. The required approach is to test goodwill (both previously
recorded and newly acquired) under the impairment approach.
c. Miscellaneous Rules
i. Worthless – write off the entire remaining cost to expense if an intangible
asset become worthless during the year (due to a technological change or
due to an unsuccessful patent defense lawsuit)
ii. Impairment – write down the intangible asset and recognized an
impairment loss if an intangible asset becomes impaired (due to a change
in circumstances that indicate that the full carrying amount of the asset
may not be recoverable).
iii. Change in Useful Life – If the life of an existing intangible asset is
reduced or extended, the remaining net book value is amortized over the
new remaining life.
iv. Sale – If an intangible asset is sold, simply compare its carrying value at
the date of sale with the selling price to determine the gain or loss.
d. Income Tax Effect—Amortization of acquired intangible assets that are not
specifically identifiable is deductible over a 15-year period in computing income
taxes payable. This may create a temporary difference, and interperiod allocation
of income taxes is appropriate.
III.
Valuation
a. U.S. GAAP: finite life intangible assets are reported at cost less amortization and
impairment. Indefinite life intangible assets are reported at cost less impairment.
b. IFRS: Intangible assets can be reported under either the cost model or the
revaluation model.
i. Cost Model: intangible assets are reported at cost adjusted for
amortization and impairment.
ii. Revaluation Model: intangible assets are initially recognized at cost then
revalued to FV at a subsequent revaluation date. Revaluated intangible
assets are reported at FV on the revaluation dated adjusted for subsequent
amortization and subsequent impairment. Revaluations must be
performed regularly so that at the end of each reporting period the CV of
the intangible asset does not differ materially from FV. If an intangible
asset is accounted for using the revaluation model, all other assets in its
class must also be revalued unless there is no active market for the
intangible assets.
1. Revaluation losses are reported on the income statement, unless the
revaluation loss reverses a previously recognized revaluation gain.
A revaluation loss that reverses a previously recognized
revaluation gain is recognized in other comprehensive income and
reduces the revaluation surplus in accumulated other
comprehensive income.
2. Revaluation gains are reported in other comprehensive income and
accumulated in equity as revaluation surplus, unless the
revaluation gain reverses a previously recognized revaluation loss.
Revaluation gains are reported on the income statement to the
extent that they reverse a previously recognized revaluation loss.
3. Impairment: If revalued intangible assets subsequently become
impaired, the impairment is recorded by first reducing any
revaluation surplus in equity to zero with further impairment losses
reported on the income statement.
IV.
Start-up Costs – Expenses incurred in the formation of a corporation (legal fees) are
considered organizational costs.
a. For Book Purposes – Start-up costs, including organizational costs, should be
expensed when incurred.
i. Start-up costs include costs of the one-time activites associated with:
1. Organizing a new entity (legal fees for preparing a charter,
partnership agreement, bylaws, original stock certifications, filing
fees, etc.)
2. Opening a new facility.
3. Introducing a new product or service.
4. Conducting business in a new territory or with a new class of
customer.
5. Initiating a new process in an existing facility.
ii. Start-up costs do not include costs associated with routine, on-going
efforts to refine, enrich, or improve the quality of existing products,
services, processes, or facilities; business mergers or acquisitions; or ongoing customer acquisition.
V.
Legal Fees
a. Fees to obtain Intangible Assets – Capitalize legal and registration fees incurred to
obtain an intangible asset because such fees establish the legal rights of the owner.
b. Legal fees incurred in defending an Intangible Asset
i. Successful = Capitalize – Capitalize legal fees incurred in successfully
defending an intangible asset because a future benefit will be derived.
ii. Unsuccessful = Expense – Fees incurred in an unsuccessful defense
should be expensed as incurred.
VI.
Goodwill – Goodwill is the representation of intangible resources and elements
connected with an entity (management or market expertise or technical skill and
knowledge that cannot be identified or valued separately). Goodwill means capitalized
excess earnings power.
a. Calculation of Goodwill
i. Acquisition Method: GW is the excess of an acquired entity’s FV over the
FV of the entity’s net assets, including identifiable intangible assets.
ii. Equity Method: Involves the purchase of a company’s capital stock. GW
is the excess of the stock purchase price over the FV of the net assets
acquired.
b. Maintaining Goodwill – Costs associated with maintaining, developing, or
restoring goodwill are not capitalized as goodwill (they are expensed). Goodwill
generated internally or not purchased in an arms length transaction also is not
capitalized as goodwill.
VII.
Franchises – Franchise operations include a franchisee that receives the right to operate
one or more units of a franchisor’s business for one or both of two types of fees.
a. Initial Franchise Fees – These fees are paid by the franchisee for receiving intial
services from the franchisor. Such services might include site selection,
supervision of construction, bookkeeping services, and quality control.
b. Continuing Franchise Fees – These fees are received for ongoing services
provided by the franchisor to the franchisee. Usually, such fees are calculated
based on a percentage of franchise revenues. Such services might include
management training, promotion, and legal assistance. Fees should be reported
by the franchisee as expense and as revenue by the franchisor, in the period
incurred.
VIII.
IX.
Research and Development Costs: Research is the planned efforts of a company to
discover new information that will help either create a new product, service, process, or
technique or significantly improve the one in current use. Development takes the
findings generated by research and formulates a plan to create the desired item or to
improve significantly the existing one.
a. Accounting for Research and Development: Under U.S. GAAP, the only
acceptable method for accounting for research and development costs is a direct
charge to expense, except for:
i. Materials, equipment, or facilities that have alternate future uses;
Capitalize and depreciate such tangible assets
ii. Research and development costs of any nature undertaken on behalf of
others under a contractual arrangement.
iii. Items not considered Research and Development
1. Routine periodic design changes to old products or trouble
shooting in production stage (these are manufacturing costs, not
research and development expenses.)
2. Marketing Research
3. Quality Control Testing
4. Reformulation of a chemical compound
Computer Software Development Costs
a. Computer Software Developed to be Sold, Leased, or Licensed
i. Technological Feasibility – Technological feasibility is established upon
completion of:
1. A detailed program design, or
2. Completion of a working model
ii. Accounting for Costs
1. Expenses costs (planning, design, coding, and testing) incurred
until technological feasibility has been established for the product.
2. Capitalize costs (coding, testing, and producing product masters)
incurred after technological feasibility has been established.
a. Amortization of Capitalized Software Costs – Annual
amortization (on a product by product basis) is the
GREATER of:
i. Straight Line = Total Capitalized Amount X
(1 / Estimate of Economic Life)
ii. Percentage of Revenue =
Total Capitalized Amount X
(Current Gross Revenue for the Period / Total
Projected Gross Revenue for Product)
3. Inventory: Costs incurred to actually produce the product are
product costs charged to inventory.
iii. Balance sheet – Capitalized software costs are reported at the LOWER OF
COST or MARKET, where MARKET = NET REALIZABLE VALUE
b. Computer Software Developed Internally or Obtained for Internal Use Only
i. Expense costs incurred in the preliminary project state and costs incurred
in training and maintenance.
ii. Capitalize costs incurred after the preliminary project state and for
upgrades and enhancements, including:
1. Direct costs of materials and services.
2. Costs of employees directly associated with project, and
3. Interest costs incurred for the project.
iii. Capitalized costs should be amortized on a straight line basis.
iv. If software previously developed for internal use is subsequently sold to
outsiders, proceeds received (from the license of computer software, net of
incremental costs) should be applied first to the carrying amount of the
software, then recognized as revenue (after the carrying amount of the
software has reached zero).
X.
Impairment – The carrying amount of identifiable intangibles and goodwill and fixed
assets held for use and to be disposed of needs to be reviewed at least annually or
whenever events or changes in circumstances indicate that the carrying amount may not
be recoverable.
a. Impairment of Intangible Assets other than Goodwill: The impairment test
applied to an intangible asset other than GW is determined by the asset’s life. An
intangible asset has a finite life when it is possible to estimate the useful life of the
asset. If it is not possible to determine the useful life of an intangible asset, then
the asset has an indefinite life. If an intangible asset has a finite life, it is
amortized over that life. If it has an indefinite life, it is not amortized.
i. Intangible Assets with Finite Lives: test for impairment using a 2-step test
1. Step 1: The CV of the asset is compared to the sum of the
undiscounted cash flow expected to result from the use of the asset
and its eventual disposition.
2. Step 2: If the CV exceeds the total undiscounted future cash flows,
then the asset is impaired and an impairment loss equal to the
difference between the CV of the asset and its FV is recorded
ii. Intangible Assets with Indefinite Lives (including GW): it is generally not
possible to estimate total future cash flows expected to result from the use
of the assets and its disposition. As a result, an intangible asset with an
indefinite life is tested for impairment by comparing the FV of the
intangible asset to its CV. If the asset’s FV is less than its CV, an
impairment loss is recognized in an amount equal to the difference.
b. Reporting an Impairment Loss: Report as a component of income from
continuing operations before income taxes. The CV of the asset is reduced by the
amount of the impairment loss. Restoration of previously recognized impairment
losses is prohibited, unless the asset is held for disposal.
c. GAAP vs. IFRS: Under IFRS, an impairment loss for an intangible asset other
than GW is calculated using a 1-step model in which the CV of the intangible
asset is compared to the intangible asset’s recoverable amount, defined as the
greater of the asset’s FV less cots to sell and the asset’s value in use. Value in use
is the present value of the future cash flows expected from the intangible asset.
IFRS allow the reversal of impairment losses.
d. Goodwill Impairment: Calculated at a reporting unit level. Impairment exists
when the CV of the reporting unit GW exceeds its FV.
i. Reporting Unit: An operating segment, or one level below an operating
segment. The GW of one reporting unit may be impaired, while the GW
for other reporting units may or may not be impaired.
ii. Evaluation of GW Impairment:
1. Step 1: Identify potential impairment by comparing the FV of
each reporting unit with its CV, including GW
2. Step 2: Measure the amount of GW impairment loss by comparing
the implied FV of the reporting unit’s GW with the CV of that
GW.