CHAPTER 12 INTANGIBLE ASSETS Overview This chapter addresses the measurement and reporting issues involving intanible assets Learning Objectives 1 2 3 4 5 6 Determine the characteristics and types of intangible assets Determine the initial cost of intangible assets Explain and calculate the periodic amortization of intangible assets Describe the accounting procedures for recording goodwill Describe the accounting for research and development costs Describe the accounting treatment for computer software costs 12 1 INTANGIBLE ASSETS Intangible assets generally represent exclusive rights that provide benefits to the owner Intangible assets include Patents Copyrights Trademarks Franchises Goodwill Despite their lack of physical existence these assets can be extremely valuable resources for a company The future benefits that we attribute to intangible assets usually are much less certain than for tangible assets Intangible assets with finite useful lives are amortized intangible assets with indefinite useful lives are not amortized 12 2 PURCHASED INTANGIBLES Valued at their original cost to include the purchase price and all other necessary costs to bring the asset to condition and location for use Patent Exclusive right to manufacture a product or to use a process granted by the U S Patent Office for a period of 20 years Attorney fees and other costs of successfully defending a patent are added When a patent is developed internally the research and development costs of doing so are expensed as incurred Copyright Exclusive right of protection given to a creator of a published work such as a song film painting photograph or book For the life of the creator plus 70 years Trademark also called tradename Exclusive right to display a word a slogan a symbol or an emblem that distinctively identifies a company product or a service Protected from use by others for an indefinite number of 10 year periods so indefinite life 12 3 Franchise Contractual arrangement providing the exclusive right to use the franchisor s trademark or tradename within a geographical area usually for a specified period of time The initial franchise fee plus any legal costs associated with the contract agreement are capitalized and then amortized over the life of the franchise agreement Periodic payments usually relate to services such as advertising provided by the franchisor on a continuing basis and are expensed as incurred 12 4 GOODWILL A unique intangible asset in that its cost can t be directly associated with any specifically identifiable right and is not separable from the company as a whole Represents the unique value of the company as a whole over and above all identifiable tangible and intangible assets Can only be purchased through the acquisition of another company Excess of the consideration exchanged over the fair value of the net assets acquired 12 5 GOODWILL continued The Smithson Corporation acquired all of the outstanding common stock of the Rider Corporation in exchange for 18 million in cash Smithson assumed all of Rider s long term debt which had a fair value of 12 million at date of acquisition The fair values of all identifiable assets of Rider are as follows in millions Receivables Inventory Property plant and equipment Patent Total 5 7 9 4 25 The cost of the goodwill resulting from the acquisition is 5 million Fair value of consideration exchanged Less Fair value of assets acquired Assets 25 Less Fair value of liabilities assumed 12 Goodwill 18 13 5 The Smithson Company records the acquisition as follows Receivables fair value Inventory fair value Property plant and equipment fair value Patent fair value Goodwill difference Liabilities fair value Cash purchase price 12 6 5 7 9 4 5 12 18 RESEARCH AND DEVELOPMENT All research and development costs are charged to expense in the period incurred R D costs entail a high degree of uncertainty of future benefits It is difficult to match R D costs with future revenues Research is planned search or critical investigation aimed at discovery of new knowledge Development is the translation of research findings into a plan for a new product or process or for a significant improvement to an existing product or process R D costs include labor costs materials depreciation and amortization of assets used in R D activities and a reasonable allocation of indirect costs related to those activities In general R D costs pertain to activities that occur prior to the start of commercial production GAAP requires disclosure of total R D expense incurred during the period 12 7 RESEARCH AND DEVELOPMENT continued Start of R D Activity Start of Commercial Production Examples of R D Costs Laboratory research aimed at discovery of new knowledge Searching for applications of new research findings or other knowledge Design construction and testing of preproduction prototypes and models Modification of the formulation or design of a product or process Sale of Product or Process Examples of Non R D Costs Engineering follow through in an early phase of commercial production Quality control during commercial production including routine testing of products Routine ongoing efforts to refine enrich or otherwise improve on the qualities of an existing product Adaptation of an existing capability to a particular requirement or customer s need as part of a continuing commercial activity 12 8 RESEARCH AND DEVELOPMENT COSTS The Askew Company made the following cash expenditures during 2011 related to the development of a new industrial plastic R D salaries and wages R D supplies consumed during 2011 Purchase of R D equipment Patent filing and legal costs Payments to others for services performed in connection with R D activities Total 10 000 000 3 000 000 5 000 000 100 000 1 200 000 19 300 000 The project resulted in a new product to be manufactured in 2012 A patent was filed with the U S Patent Office The equipment purchased will be employed in other projects Depreciation on the equipment for 2011 was 500 000 The various expenditures would be recorded as follows R D expense 14 200 000 10 000 000 3 000 000 1 200 000 Cash 14 200 000 Equipment 5 000 000 Cash 5 000 000 R D expense Accumulated depreciation equipment 500 000 Patent Cash 100 000 12 9 500 000 100 000 COMPUTER SOFTWARE DEVELOPMENT COSTS GAAP requires the capitalization of software development costs incurred after technological feasibility is established Technological feasibility is established when the enterprise has completed