A LITTLE BACKGROUND
INTANGIBLE ASSETS
Before “corporate scandal” was the number one focus,
intangible asset valuation, and amortization periods were
among the most scrutinized aspects of financial reportingAND STILL ARE VERY HIGH PRIORITIES
Chapter
12
Intangible assets represent nearly 50% of the balance sheet
these days.
Prior to FAS 142, goodwill was amortized. Now it, and
intangibles with “indefinite useful lives” are no longer
amortized. Can you say “ticking time bomb”? Also, how
about our old friend the matching principle- where did it go?
NOT amortizing goodwill is one of the very first examples of
“Convergence”.
Bob Anderson, UCSB 2004
12-1
12-2
Bob Anderson, 2004
10:24
Intangibles Defined
Valuation
Purchased Intangibles - At cost, which includes ...
Assets (not including financial assets) that
lack physical substance.
all expenditures necessary to make asset ready for its
intended use.
Internally-Created Intangibles - Generally expensed as incurred.
Amortization - Limited useful life – AMORTIZE, over estimated life

Test for impairment under same rules as fixed assets..


Bob Anderson, 2004
12-3
Remember? IF “event or change in circumstance” then do the
undiscounted cash flow analysis.
Indefinite useful life – No AMORTIZATION, BUT annual
impairment testing required… no “if”- ALWAYS ONCE/
YEAR
Bob Anderson, 2004
12-4
Amortization
Types of Intangibles
Limited-Life Intangibles -The useful life should reflect the periods over which
these assets will contribute to cash flows
(MATCHING)
Indefinite-Life Intangibles—
There is no foreseeable limit on the period of time over
which the intangible asset is expected to provide cash
flows.
 Test for impairment at least annually

Trademark or Trade NameRegistration with the U.S. Patent and Trademark
Office provides legal protection for an indefinite
number of renewals of periods of 10 years each.
Amortizable?
NO- Indefinite life- test for impairment annually
(more on impairment testing later)
 Direct costs capitalizable (i.e attorney fees)

Customer Lists
 Capitalizable if you bought it, if internally
generated, nope.
FIRST compare estimated fair value of business to NBV, if
FV>NBV, done, if not…
Write Goodwill down until FV of the business= its NBV
IMPAIRMENT TESTING DISCUSSED MORE LATER
Bob Anderson, 2004
12-5
Bob Anderson, 2004
12-6
10:24
Types of Intangibles- Continued
NOT AN INTANGIBLE
Copyright



Granted for the life of the creator plus
70 years.
Franchise, License, and Permits
Patent


right to use, manufacture, and sell a
product or process for a period of 20
years.


Goodwill- we will discuss at length!
Bob Anderson, 2004

Costs to internally develop an intangible
Organizational costs (SOP 98-5)
Unless ACQUIRED, these are NOT capitalized
as intangibles (expense as incur)
12-7
Customer mailing lists;
Brand name;
Just about anything which is not tangible and
not acquired
Bob Anderson, 2004
12-8
Exercise 12-4
Exercise 12-4
1. Alatorre purchased a patent from Vania
Co. for $1,000,000 on January 1, 2005.
The patent is being amortized over its
remaining legal life of 10 years, expiring
on January 1, 2015. During 2007, Alatorre
determined that the economic benefits of
the patent would not last longer than 6
years from the date of acquisition. What
amount should be reported in the balance
sheet for the patent, net of accumulated
amortization, at December 31, 2007?
1.
Amortization for 2005 & 2006 -($1,000,000/10) x 2
years
$200,000
2007 amortization -(1,000,000-200,000) / 4 years
200,000
Accumulated amortization
$400,000
12-9
Bob Anderson, 2004
12-10
Bob Anderson, 2004
10:24
Exercise 12-4
Exercise 12-4
2.Altorre bought a franchise from Alexander
Co. on January 1, 2006, for $400,000. Its
carrying amount on Alexander’s books at
January 1, 2006, was $500,000. The
franchise had an estimated useful life of
30 years. Because Alatorre must enter a
competitive bidding at the end of 2015, it
is unlikely that the franchise will be
retained beyond 2015. What amount
should be amortized for the year ended
December 31, 2007?
Bob Anderson, 2004
12-11
2.
$400,000 / 10 = $40,000
Bob Anderson, 2004
12-12
Exercise 12-4
Exercise 12-4
3.
On January 1, 2007, Alatorre incurred
organization costs of $275,000. What
amount should be expensed in 2007?
3.
These costs should be expensed as incurred. So
ALL OF IT!!!!
12-13
Bob Anderson, 2004
12-14
Bob Anderson, 2004
10:24


Goodwill
Example
Goodwill can ONLY be purchased in
connection with the purchase of a business.
Goodwill is recorded as the excess of ...
Global Corporation purchased the net assets of
Local Company for $300,000 on December
31, 2000. The balance sheet of Local
Company just prior to acquisition is show on
the next slide.
purchase price over the FMV of the
identifiable net assets acquired.
In other words, the portion of the purchase
price which is not supported by what you
bought.- you must have paid for somethingthat something is goodwill.
Bob Anderson, 2004
12-15
Bob Anderson, 2004
12-16
Recording Goodwill
ASSETS
Cash
Receivables
Inventories
PP&E
Total assets
Cost
15,000
10,000
50,000
80,000
155,000
FMV
15,000
10,000
70,000
130,000
225,000
Recording Goodwill
Inc.(Dec.)
20,000
50,000
ASSET S
Cash
Receivables
Inventories
PP&E
T otal assets
Cost
15,000
10,000
50,000
80,000
155,000
FMV
15,000
10,000
70,000
130,000
225,000
Inc.(Dec.)
20,000
50,000
What are the Net Assets?
EQUITIES
Current liabilities 25,000
Capital stock
100,000
Retained earning 30,000
Total equities 155,000
25,000
-
25,000
Bob Anderson, UCSB 2004
12-17
EQUIT IES
Current liabilities 25,000
Capital stock
100,000
Retained earning 30,000
T otal equities
155,000
25,000
-
25,000
Bob Anderson, UCSB 2004
12-18
10:24
Recording Goodwill
Recording Goodwill
ASSET S
Cost
15,000
10,000
50,000
80,000
155,000
FMV
15,000
10,000
70,000
130,000
225,000
Inc.(Dec.)
20,000
50,000
130,000
EQUIT IES
Current liabilities 25,000
Capital stock
100,000
Retained earning 30,000
T otal equities
155,000
200,000
Net Assets
Cash
Receivables
Inventories
PP&E
T otal assets
Bob Anderson, UCSB 2004
25,000
Is there any Goodwill?
-
25,000
12-19
Bob Anderson, 2004
12-20
Recording Goodwill
Recording Goodwill
Is there any Goodwill?
Is there any Goodwill?
Book Value = $130,000
Book Value = $130,000
Revaluation
$70,000
Fair Value = $200,000
Fair Value = $200,000
Purchase Price = $300,000
Purchase Price = $300,000
12-21
Bob Anderson, 2004
Bob Anderson, 2004
12-22
10:24
Recording Goodwill
JOURNAL ENTRY:
Cash
15,000
A/R
10,000
Inventory 70,000
PP&E
130,000
Current liab.
25,000
Cash
300,000
Goodwill 100,000
Is there any Goodwill?
Book Value = $130,000
Revaluation
$70,000
Fair Value = $200,000
Goodwill
$100,000
Purchase Price = $300,000
Bob Anderson, 2004
12-23
Bob Anderson, 2004
12-24
JOURNAL ENTRY (if mailing list
was valued at $25,000):
WHAT IF?

In prior example, what if the acquired company
had developed a mailing list that we got. Because
it was internally generated, the seller has no asset.
Does this asset have a value even if not on seller’s
books?
OF COURSE
 If we acquire it, can we record that asset?
YES
 Would this impact your goodwill?
Goodwill recorded would be impacted by the amount of the
capitalized intangible.

12-25
Bob Anderson, 2004
Cash
15,000
A/R
10,000
GOODWILL IS A PLUG:
Inventory 70,000
THE MORE THE IDENTIFIABLE ASSETS,
THE LESS THE GOODWILL
PP&E
130,000
Intang.
25,000
Current liab.
25,000
Cash
300,000
Goodwill 75,000
Bob Anderson, 2004
12-26
10:24
IMPAIRMENT TESTING
Negative Goodwill
Indefinite Life Intangibles, EXCLUDING GOODWILL REMEMBER these do not get amortized
When FMV of the acquired assets is higher than
the purchase price.
FASB requires that this remaining excess be
recognized as an gain.
NOTE: NOT AN EXTRAORDINARY GAIN=
RECENT CHANGE IN GAAP.

Annually estimate fair-market value and adjust if carrying
value is greater than fair value
Definite Life Intangibles These do get amortized, and therefore it is assumed
that they ratably decline in value on the balance
sheet, matching their Value, so…

Only test for impairment if there has been an event or
change in circumstance indicating that an impairment may
have occurred


Bob Anderson, 2004
12-27
Test One: Event or change in circumstance? If not, done;
Test Two: Undiscounted cash flows. If pass, done;
Impairment: Measured as the excess of carrying value over Fair
Value.
Bob Anderson, 2004
12-28
Definite-Life Intangible Impairment
Trademark with 5 years remaining has been amortized to $200,000. There has been an advancement in a
competitor's trademark which is deemed an "event or change in circumstance" which may impair our
trademark. We have estimated the future cash flows as follows:
Undiscounted cash flows
Total
175,000
Year 1
100,000
Year 2
50,000
Year 3
10,000
Year 4
10,000
Year 5
5,000
Because the undiscounted cash flows of $175,000 is less than the NBV of $200,000, there has been an
impairment. We have to estimate the fair value then of our intangible. Most likely we will just DISCOUNT the
cash flows. Using a rate of 8%, they are:
Discounted cash flows
Total
160,198
Year 1
96,225
Year 2
44,549
Year 3
8,250
Year 4
7,639
Year 5
3,536
IMPAIRMENT TEST: GOODWILL
It is a two-step process:
Step 1: Estimate the fair value of the reporting unit in which the goodwill is
recorded. Excess of the reporting units value over it’s NBV (including
goodwill) indicates no impairment. If FV>NBV, done. BUT if not, then:
Step 2: Estimate the “implied fair value of goodwill” by comparing the fair
value of the reporting unit to the FAIR VALUE OF THE NET ASSETS
(excluding goodwill)- INCLUDING ANY INT. Adjust goodwill to its implied
fair value.
Therefore our estimated impairment is:
Estimated fair value
Less NBV
IMPAIRMENT
IMPORTANT NOTE: Not in scope of class, but always fix any other
impairments in a reporting unit before revaluing goodwill
160,198
200,000
39,802
ENTRY:
Impairment (or amortization) expense
Accum. Amortization
39,802
39,802
12-29
Bob Anderson, 2004
Bob Anderson, 2004
12-30
10:24
Goodwill
Impairment Example
NOT the same as the textbook example (similar):
Indefinite life intangible test
Reporting Unit Balance Sheet
NBV
Cash
Receivables
Inventory
PP&E, Net
Goodw ill
Less: all liab.
Net assets of reporting unit
200,000
300,000
700,000
800,000
900,000
(500,000)
2,400,000
Estimate fair value annually and adjust
DOWNWARD ONLY if there is an impairment.
F. Value
200,000
300,000
750,000
810,000
???
(500,000)
1,560,000
Pretty simple: B/C we don’t have to estimate
the fair value in this class!!!
STEP 1: Compare to fair value of reporting unit.
If fair value of the reporting unit is $2.8 million, step one passed and w e are done.
BUT if the fair value of the reporting unit is $1.9 million, w e have a problem and have
STEP 2: Compute "implied fair value of goodw ill"
Reporting unit value
Fair value of reporting unit net assets, excluding g. w ill
Implied fair value of goodw ill
1,900,000
1,560,000
340,000
COMPUTE IMPAIRMENT:
Goodw ill on books
Implied fair value
GOODWILL IMPAIRMENT
ENTRY:
Impairment expense
Goodw ill
Bob Anderson, 2004
900,000
(340,000)
560,000
560,000
560,000
12-31
Bob Anderson, 2004
12-32
COMBINED
Cash
Cash
Receivables
Indefinite life intangible
Definite life intangible, net
Inventory
PP&E, Net
Goodwill
Less: all liab.
Net assets of reporting unit
(a)
(b)
(C )
200,000
300,000
125,000
175,000
700,000
800,000
900,000
(500,000)
2,700,000
Deal with these first!
Research and Development
AFTER IMPAIRMENTS
200,000
300,000
115,000
175,000
700,000
800,000
900,000
(500,000)
2,690,000
Research Activities:
(a) This is an indefinite life intangible. We perform annual fair value estimate and determine that it is overvalued by $10k
(b) This is being amortized, we only test if it has "an indication of a change in circumstance". If there had been no change, then stop. But
lets say there was, then we would do an undiscounted cash flow analysis. The undiscounted cash flows exceed the NBV, so we are done.
BUT if not, then we would estimate fair value (probably by discounting the cash flows) and record the impairment.
(C ) Fixed assets just like we treat definite lived intangibles. We will assume that no "events or change in circumstance"
Examples:
Laboratory research aimed at discovery of new
knowledge; searching for applications of new
research findings.
STEP 1: Compare to fair value of reporting unit.
If fair value of the reporting unit is $2.8 million, step one passed and we are done.
BUT if the fair value of the reporting unit is $2.5 million, we have a problem and have to do step 2
STEP 2: Compute "implied fair value of goodwill"
Net assets of reporting unit, excluding goodwill
Fair value of reporting unit
Implied fair value of goodwill
1,790,000
2,500,000
710,000
COMPUTE IMPAIRMENT:
Goodwill on books
Implied fair value
GOODWILL IMPAIRMENT
ENTRY:
Impairment expense
Goodwill
Planned search or critical investigation aimed at
discovery of new knowledge.
900,000
(710,000)
190,000
190,000
190,000
Bob Anderson, 2004
12-33
Bob Anderson, 2004
12-34
10:24
Research and Development
Development Activities:
Translation of research findings or other knowledge into a
plan or design for a new product or process or for a
significant improvement to an existing product or process
whether intended for sale or use.
Examples:
Conceptual formulation and design of possible product
or process alternatives; construction of prototypes
and operation of pilot plants.
R & D excludes expenditures for:
 Legal work, routine improvements, or periodic
retooling.
 Research related to selling and administrative
activities.
Bob Anderson, 2004
12-35
Cost Associated with R & D
ARE GENERALLY EXPENSED AS INCURRED
1Materials, equipment, and facilities
2- Personnel
3- Purchased R&D, unless has value to
future R&D, then capitalize and expense
with that future R&D
4- Contract services
5- Indirect costs
Bob Anderson, 2004
12-36
Exercise
Item
Exercise
Classification
1. Investment in a subsidiary company
2. Timberland
3. Cost of engineering activity required
to advance the design of a product
to the manufacturing stage.
4. Lease prepayment
5. Cost of equipment obtained under a
capital lease.
6. Cost of searching for applications of
new research findings.
7. Cost incurred in the formation of a
corporation.
Item
1. Long-term investments
2. PP & E
3. R & D expense
8.
9.
4. Prepaid rent
5. PP & E
10.
11.
12.
6. R & D expense
13.
7. Expense
14.
12-37
Bob Anderson, 2004
Classification
Operating losses incurred in the
start-up of a business.
Training costs incurred in start-up
of new operation.
Purchase cost of a franchise.
Goodwill generated internally.
Cost of testing in search of product
alternatives.
Goodwill acquired in the purchase
of a business.
Cost of developing a patent.
8.
Operating losses
9.
Expense
10. Intangible
11. Not recorded/ expensed
12. R & D expense
13. Intangible
14. R & D expense
12-38
Bob Anderson, 2004
10:24
Exercise
Item
15. Cost of purchasing a patent from
an inventor.
16. Legal costs incurred in securing a
patent.
17. Unrecovered costs of a successful
legal suit to protect the patent.
18. Cost of conceptual formulation of
possible product alternatives.
19. Cost of purchasing a copyright.
20. Research and development costs.
21. Cost of developing a trademark.
22. Cost of purchasing a trademark.
Bob Anderson, 2004
Exercise
Classification
Josha Company incurred the following costs during 2001:
15. Intangible
Quality control during commercial production, including
$58,000
routine testing of products.
16. Intangible
R&D
$0
Laboratory research aimed at discovery of new
knowledge
68,000
68,000
17. Intangible
Engineering follow-through in an early phase of
commercial production.
15,000
0
18. R & D expense
Adaptation of an existing capability to a particular
requirement or customer’s need as part of continuing
13,000
commercial production.
Trouble-shooting in connection with breakdowns during
29,000
commercial production.
19,000
Searching for applications of new research findings.
19.
20.
21.
22.
Intangible
R & D expense
Expensed
Intangible
Compute research and development costs for 2001.
12-39
Bob Anderson, 2004
0
0
19,000
$87,000
12-40
Exercise
INTANGIBLE EXPENDITURE
Purchased
More Company incurred the following costs during 2001:
$280,000 / 5 =
Cost of equipment acquired that will have
$56,000
alternative uses in future R&D projects over the
$280,000
next 5 years.
$56,000
59,000
59,000
Materials consumed in R&D projects
R&D
Consulting fees paid to outsiders for R&D projects
100,000
100,000
Personnel costs of persons involved in R&D
projects
128,000
128,000
Indirect costs reasonably allocable to R&D projects
50,000
50,000
Materials purchased for future R&D projects
34,000
0
Compute research and development costs for 2001.
$393,000
12-41
Bob Anderson, 2004
Is it g. will in connxn w/ purch of a business
or
Related to an existing product (not R&D)
Or
Purchase of a legitimate existing intangible?
Yes
Internally generated
No
Generally expense as incurred
(unless purchased R&D for future
periods-then capitalize and
Expense as R&D when used)
Generally capitalize as an
intangible asset
Indefinite Life
-NO amortization
-Annual Impairment
testing (as per Chapter 12)
Definite life
-Amortize
-Impairment testing only when
“event or change in circumstance”
(as per Chapter 11)
12-42
Bob Anderson, 2004
10:24
Other concepts
Chapter 12
Advertising: Generally expense as incurred
unless you can establish that the benefit has
not yet occurred (generating a prepaid
expense)
Bob Anderson, 2004
12-43
Done!!
Bob Anderson, UCSB 2004
12-44