Intangible assets
1
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

2
Example of intangible assets
Goodwill
 Research and development expenditures
 Patents
 Copyrights
 Franchises
 Trademarks

3
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
4
Accounting for an intangible
asset
5
To record the cost of an
intangible asset
Dr. Intangible assets
Cr. Bank
6



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
7
To write off the expenditure
incurred from which no
intangible asset can be created
Dr. Profit and loss
Cr. Bank
8

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 reorganizing part of all of an enterprises

9

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
10
To recognize the subsequent
expenditure as an intangible asset
Dr. Intangible assets
Cr. Bank
11

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
12
To record the provision for
amortization
Dr. Profit and loss
Cr. Accumulated amortization
13
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)

14
To record the provision for
impairment loss
Dr. Profit and loss
Dr. Accumulated amortization
Cr. Intangible assets
15

When the carrying amount (cost less
accumulated amortization) exceeds the
recoverable amount of an intangible asset,
there is an impairment loss
16
After revaluation
To record
revaluation
surplus
Dr. Intangible asset
Dr. Accumulated amortization
Cr. Revaluation reserve
To record the
Dr. Intangible asset
reversal of
Dr. Accumulated amortization
previous
Cr. Profit and loss
impairment loss
that was
recognized as an
expenses
17
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

18
Accounting for Goodwill
19
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)
20
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
21
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.

22
Why intrinsic?
Its existence depends on the
continuance of the business. It cannot
be realized separately from the business
as a whole.
back
Calculation of goodwill
Subjective Judgement
 Average Sales/Fees/Profits Method
 Super Profit Method

24
Subject Judgement

Estimate the value of goodwill with reference
to some intangible factors and according to
their professional judgement
25
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
26
Example 1
27
Year
Annual Sales
$
1995
1996
1997
100000
200000
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
28
(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)
29
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 profit
Less: Reasonable remuneration to the owner
X
X
Reasonable return on the capital employed in the
tangible assets
Super profit
X
X
30
X
Example 2
31



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.
32
Answer
Statement Calculating Super Profit
$
Average net profit
(5000+6500+6500+7000)/4
Less: Management fee
500
Expected rate of return
on net tangible assets
5000
Super profit
$
6250
5500
750
Goodwill= $750 X 3
= $2250
33
Different types of goodwill
Inherent goodwill
 Purchased goodwill
 Negative goodwill

34
Inherent goodwill
35
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

36
Accounting treatment

Non-purchased goodwill should not be
recognized in the financial statements
37
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
38
Purchased goodwill
39
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

40
Accounting treatments

Purchased goodwill is recorded at cost less
any accumulated amortization and any
accumulated impairment losses
41
To record the cost of goodwill
Dr. Goodwill
Cr. Business purchase
42
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
43
To record the provision for
amortization
Dr. Profit and loss
Cr. Accumulated amortization
44
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)

45
To record the impairment loss
Dr. Other assets
Dr. Goodwill
Cr. Profit and loss
46
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

47
Revaluation
No entry
48

There is no active market, hence goodwill
should not be revaluated
49
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

50
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

51
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
52
Example
53
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
54
3 steps for accounting negative goodwill are shown as
follows:
(a) Ascertain the amount of the negative goodwill
1 Jan 2001
Dr. 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 2001 Dr. Negative goodwill $15000
Cr. Profit and loss
$15000
31 Dec 2002 Dr. 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
55
•
$90000 will be credited to P/L immediately
Accounting for Goodwill in
Partnership
56
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
57

Each partner has a share of the profitsharing 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
58
Goodwill on the admission of a new
partner
59
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
60
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
61
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
Share goodwill among old partners in old
Cr Capital account (old profit-sharing ratio
partners only)
Dr Capital account ( all Written off goodwill among all partners
partners)
in the new profit-sharing ratio
Cr Goodwill account

62
Example 3
63



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
Assets
1,200
1,200
Capital
Chan
Wong
600
600
1,200
64
Goodwill account opened
Goodwill
150
Balance c/f
150
Capital: Chan (1/2)
Wong (1/2)
300
300
300
Capital
Balance c/f
Chan
Wong
Lee
750
750
600
750
750
600
Chan
Wong
Balance b/f
600
600
Goodwill
Cash
150
150
Lee
600
750
750
600
65
Goodwill account opened
Balance Sheet as at 31 December 1998
Assets
Goodwill
Other Assets (1,200 + 600)
300
1,800
2,100
Capital
Chan
Wong
Lee
New capital balance
750
750
600
2,100
66
Goodwill accountCapital
not opened
Chan
Goodwill :
new ratio
Balance c/f
Wong
Lee
Balance b/f
100
650
100
650
100
500
750
750
600
Before admission
Chan
Wong
600
600
Goodwill: old ratio 150
Cash
750
Lee
150
600
750
600
After admission
Partner
Old ratio
Share of
goodwill
New ratio
Share of
goodwill
Gain/loss
Chan
1/2
$150
1/3
$100
$50 loss
Wong
1/2
$150
1/3
$100
$50 loss
1/3
$100
$100 gain
Lee
$300
$300
67
Goodwill account not opened
Balance Sheet as at 31 December 1998
Assets
Assets (1,200 + 600)
1,800
1,800
Capital
Chan
Wong
Lee
650
650
500
1,800
68
Accounting for Research and
Development Expenditures
69
Definition

Pure research


Applied research


An investigation undertaken in order to gain new
scientific knowledge but not directed towards any
specific aim or application
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
70
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

71
Accounting treatment –
development cost

Development expenditures

Development expenditures should be written
off as incurred
OR

Development expenditures can be deferred to
future periods and recorded as an asset
72

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
73



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
74
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

75
Accounting for Trademark
76
Definition

A trademark is the legal protection afforded
the names, symbols, and other specific
identities assigned to a product
77
Valuation of trademark

The costs capitalized include design,
registration and the legal cost of
successfully defending the trademark in
court
78
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

79
Accounting for Patent
80
Definition

A patent is an exclusive right to use,
manufacture, process, or sell a product
granted by the government
81
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
82
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

83
Accounting for Copyright
84
Definition

A copyright is the exclusive rights of the
creator or heirs to reproduce or sell an
artistic or published work
85
Valuation of copyright

It is recorded at its acquisition price
86
Accounting treatment

A copyright should be amortized over the
shorter of its economic or legal life
87
Accounting for franchise

A franchise is an exclusive rights granted to
a franchise permitting him to operate using
the franchiser’s name
88
Valuation of franchise

The franchise must pay a franchise fee for
such rights
89
Accounting treatment

A franchise should be amortized over its
economic life
90