University of Southern Philippines Foundation

College of Accountancy

Intermediate Accounting 1

Module.07_Financial Reporting for Intangible Assets

Introduction

Intangible assets are identifiable non-monetary asset without physical substance. While intangible assets do not have a physical
substance, they add value to your business. Intangible assets are long-term assets, meaning you will use them at your company for
more than one year. Examples of intangible assets include goodwill, brand recognition, copyrights, patents, trademarks, trade names,
and customer lists. This module focuses on the accounting and reporting for intangible asset in accordance with PAS 38. This module
presents the recognition principle, measurement, presentation and disclosure requirements of intangible assets. It introduces the
learner to the proper accounting treatment of intangible assets through the online lecture, develops the learner’s understanding of the
requirements through the use of examples and indicates significant judgements that are required in accounting for intangible assets.
Furthermore, the module includes questions designed to test the learner’s knowledge of the requirements and to develop the learner’s
ability to account for intangible assets in accordance with PAS 38.

Learning Outcomes

At the end of this module you MUST be able to:

1. Determine when to recognize and derecognize Intangible Assets.
2. Calculate the initial and subsequent measurement of intangible assets that have finite and indefinite useful life.
3. Compute amortization of Intangible assets.

Learning Activities:

1. Submission of assignment through Canvas.

2. Read lecture notes.
3. Answer pre-assessment activities through Canvas.
4. Download the pre-recorded lecture.

Lecture Notes

Nature of Intangible Assets

Intangible asset is an identifiable nonmonetary asset without physical substance.

Critical attributes of an intangible asset:

 identifiability
 control (power to obtain benefits from the asset)
 future economic benefits (such as revenues or reduced future costs)

Identifiability: An intangible asset is identifiable when it:

 is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or as part of a
package) or
 arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or
from other rights and obligations.

Types of Intangible Assets

• Marketing-related
• Customer-related
• Artistic-related
• Contract-related
• Technology-related
• Goodwill

Marketing-related intangible assets are those assets primarily used in the marketing or promotion of products or services.

Examples
 • Trademarks or trade names
• Newspaper masthead
• Internet domain names
• Noncompetition agreements

Customer-related intangible assets occur as a result of interactions with outside parties.

Examples
• Customer lists
• Order or production backlogs
• Both contractual and noncontractual customer relationships

Artistic-related intangible assets involve ownership rights to plays, literary works, musical works, pictures, photographs, and video
and audiovisual material. These ownership rights are protected by copyrights.
Contract-related intangible assets represent the value of rights that arise from contractual arrangements.

Examples
• Franchise and licensing agreements
• Construction permits
• Broadcast rights
• Service or supply contracts.

Technology-related intangible assets relate to innovations or technological advances.

Examples
• Patented technology
• Trade secrets

Recognition

PAS 38 requires an entity to recognize an intangible asset, whether purchased or self-created (at cost) if, and only if:
 it is probable that the future economic benefits that are attributable to the asset will flow to the entity; and
 the cost of the asset can be measured reliably.

This requirement applies whether an intangible asset is acquired externally or generated internally. PAS 38 includes additional
recognition criteria for internally generated intangible assets.

The probability of future economic benefits must be based on reasonable and supportable assumptions about conditions that will exist
over the life of the asset. The probability recognition criterion is always considered to be satisfied for intangible assets that are
acquired separately or in a business combination.

If recognition criteria not met. If an intangible item does not meet both the definition of and the criteria for recognition as an
intangible asset, PAS 38 requires the expenditure on this item to be recognized as an expense when it is incurred.

Business combinations. There is a rebuttable presumption that the fair value (and therefore the cost) of an intangible asset acquired in
a business combination can be measured reliably. An expenditure (included in the cost of acquisition) on an intangible item that does
not meet both the definition of and recognition criteria for an intangible asset should form part of the amount attributed to the goodwill
recognized at the acquisition date. PAS 38 notes, however, that non-recognition due to measurement reliability should be rare.

The only circumstances in which it might not be possible to measure reliably the fair value of an intangible asset acquired in a
business combination are when the intangible asset arises from legal or other contractual rights and either:
 is not separable; or
 is separable, but there is no history or evidence of exchange transactions for the same or similar assets, and otherwise estimating
fair value would be dependent on immeasurable variables.

Reinstatement. PAS 38 also prohibits an entity from subsequently reinstating as an intangible asset, at a later date, an expenditure that
was originally charged to expense.

Research and Development Costs

Research - original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and
understanding.

Development - application of research findings or other knowledge to a plan or design for the production of new or substantially
improved materials, devices, products, processes, systems or services before the start of commercial production or use.

Initial Recognition:
 Charge all research cost to expense.
 Development costs are capitalized only after technical and commercial feasibility of the asset for sale or use have been
established. This means that the entity must intend and be able to complete the intangible asset and either use it or sell it and be
able to demonstrate how the asset will generate future economic benefits.

If an entity cannot distinguish the research phase of an internal project to create an intangible asset from the development phase, the
entity treats the expenditure for that project as if it were incurred in the research phase only.

Initial Recognition: In-process Research and Development Acquired in a Business Combination

A research and development project acquired in a business combination is recognized as an asset at cost, even if a component is
research. Subsequent expenditure on that project is accounted for as any other research and development cost (expensed except to the
extent that the expenditure satisfies the criteria in PAS 38 for recognizing such expenditure as an intangible asset).

Initial Recognition: Internally Generated Brands, Mastheads, Titles, Lists

Brands, mastheads, publishing titles, customer lists and items similar in substance that are internally generated should not be
recognized as assets.
Initial Recognition: Computer Software
 Purchased: capitalize
 Operating system for hardware: include in hardware cost
 Internally developed (whether for use or sale): charge to expense until technological feasibility, probable future benefits, intent
and ability to use or sell the software, resources to complete the software, and ability to measure cost.
 Amortization: over useful life, based on pattern of benefits (straight-line is the default).

Initial Recognition: Certain Other Defined Types of Costs

The following items must be charged to expense when incurred:

 internally generated goodwill
 start-up, pre-opening, and pre-operating costs
 training cost
 advertising cost
 relocation costs

Initial Measurement

Intangible assets are initially measured at cost.

Measurement Subsequent to Acquisition

An entity must choose either the cost model or the revaluation model for each class of intangible asset.

Cost model. After initial recognition the benchmark treatment is that intangible assets should be carried at cost less any amortization
and impairment losses.

Revaluation model. Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent amortization and
impairment losses only if fair value can be determined by reference to an active market. Such active markets are expected to be
uncommon for intangible assets.

Classification of Intangible Assets Based on Useful Life

Intangible assets are classified as:

 Indefinite life: No foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.

 Finite life: A limited period of benefit to the entity.

Measurement Subsequent to Acquisition: Intangible Assets with Finite Lives

The cost less residual value of an intangible asset with a finite useful life should be amortized over that life:
 The amortization method should reflect the pattern of benefits.
 If the pattern cannot be determined reliably, amortize by the straight line method.
 The amortization charge is recognized in profit or loss unless another PFRS requires that it be included in the cost of another
asset.
 The amortization period should be reviewed at least annually.

The asset should also be assessed for impairment in accordance with PAS 36.

Measurement Subsequent to Acquisition: Intangible Assets with Indefinite Lives

An intangible asset with an indefinite useful life should not be amortized.

Its useful life should be reviewed each reporting period to determine whether events and circumstances continue to support an
indefinite useful life assessment for that asset. If they do not, the change in the useful life assessment from indefinite to finite should
be accounted for as a change in an accounting estimate.

The asset should also be assessed for impairment in accordance with PAS 36.

Subsequent Expenditure

Subsequent expenditure on an intangible asset after its purchase or completion should be recognized as an expense when it is incurred,
unless it is probable that this expenditure will enable the asset to generate future economic benefits in excess of its originally assessed
standard of performance and the expenditure can be measured and attributed to the asset reliably.

Accounting for Specific Intangible Assets

Patent

A patent gives the holder exclusive right to use, manufacture, and sell a product or a process without interference or infringement by
others.

Acquired
Same manner with PPE

Internally generated
Expensed – R&D costs related to the development of the product, process, or idea that is subsequently patented

Capitalized – Costs to secure the patent right

Amortization - Over its legal life (20 years) or its useful life, whichever is shorter.

Trademark

A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular entity or product.

Measurement – Same manner with patents

Legal life
Legal protection for an indefinite number of renewals for a period of 10 years each

Amortization
Limited life - Amortized over the life of the trademark
Indefinite life - not amortized

Franchise

A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or services,
to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area.

Fees related to franchise

Initial – capitalized; amount depends on the manner of payment
Periodic – expensed when incurred

Amortization
Limited life - Amortized over the life of the franchise
Indefinite life - not amortized

Goodwill

An asset representing the future economic benefits arising from other assets acquired in a business combination that are not
individually identified and separately recognized. (PFRS 3 Appendix)

Determination of Goodwill

Specific attributes approach

The attributes and components of goodwill are identified and valued accordingly.

Residual Approach (Indirect valuation)

Goodwill is the difference between the purchase price and the fair value of identifiable net assets acquired.
Excess earnings approach (Direct Valuation)

1. Purchase of average earnings.

Average earnings Pxx

Less normal earnings
(FV of Net Asset x Normal rate of return) xx
Excess earnings xx
x number of years x
Goodwill Pxx

2. Capitalization of average excess earnings

Average earnings Pxx

Less normal earnings
(FV of NA x Normal rate of return) xx
Excess earnings xx
/ Capitalization rate %
Goodwill Pxx

3. Capitalization of average earnings

Average earnings Pxx

/ Capitalization rate %

Net assets, including goodwill xx

Less net assets, excluding goodwill Xx
Goodwill Pxx

4. Present value of average excess earnings

Average earnings Pxx

Less normal earnings
(FV of NA x Normal rate of return) xx
Excess earnings xx
x PVF using an appropriate rate xx
Goodwill Pxx

-- end of lecture notes --

Pre-Assessment Activity on Intangible Assets

1. Determine the amount to be recognized as intangible assets from the following data:

Deposits with advertising agency which will be used to promote goodwill P 45,000
Excess of cost over net assets of purchased subsidiary 400,000
Franchise to operate a local fast food 100,000
Marketing costs of introducing new products 150,000
Organization cost 50,000
Patents 244,000
Research and development costs expected to benefit future periods 420,000
Research and development cost not expected to benefit future periods 300,000
Unamortized bond discount 155,000

Excess of cost over net assets of purchased subsidiary 400,000

Franchise to operate a local fast food 100,000
Patents 244,000
Total Intangible Assets 744,000

1. Wagkang Corp. is engaged in a research and development project to produce a new product. In the year ended December 31,
2018, the company spent P1,200,000 on research and concluded that there were sufficient grounds to carry the project on to its
development stage and a further P750,000 had been spent on development. At that date management had decided that they were
not sufficiently confident in the ultimate profitability of the project and wrote off all the expenditure to date to the income
statement. In 2019 further direct development costs have been incurred of P800,000 and the development work is now almost
complete with only an estimated P100,000 of costs to be incurred in the future. Production is expected to commence within the
next few months. Unfortunately the total trading profit from sales of the new product is not expected to be as good as market
research data originally forecasted and is estimated at only P1,500,000. Assuming the other criteria given in PAS 38 are met, how
much should be capitalized as of December 31, 2019?
2. Mag-alala Company incurred the following costs during the current year:

Quality control during commercial production, including routine testing of products P58,000
Laboratory research aimed at discovery of new knowledge 68,000
Testing for evaluation of new products 24,000
Modification of the formulation of a plastic product 26,000
Engineering follow-through in an early phase of commercial production 15,000
Adaptation of an existing capability to a particular requirement or customer's need as a part of continuing
commercial activity 13,000
Trouble-shooting in connection with breakdowns during commercial production 29,000
Searching for applications of new research findings 19,000

What is the total amount Mag-alala should report as research and development expense?

Research - EXPENSE
Development - generally EXPENSED
When to recognize development cost? (all criteria is met then recognize)
1. technical feasibility
2. Intention to complete or sell
3. Ability to use or sell
4. Probable future economic benefit
5. availability of resources
6. ability to measure cost reliably

RESEARCH DEVELOPMENT PRODUCTION

EXPENSE GEN. EXPENSE INVENTORY

Laboratory research aimed at discovery of new knowledge 68,000

Testing for evaluation of new products 24,000
Modification of the formulation of a plastic product 26,000
Searching for applications of new research findings 19,000
Total R & D expense 137,000

3. Di ko Company provided the following information relevant to the research and development expenditures for the current year:

Current period depreciation on the building housing R and D activities P1,500,000

Cost of market research study 1,000,000
Current period depreciation on a machine used in R and D activities 500,000
Salary of R and D director 1,200,000
Salary of Vice-President who spends ¼ of his time overseeing R and D activities 2,400,000
Pension costs for salary of R and D director 50,000
Pension costs for salary of Vice-President 100,000

The R and D expense for the current period should be..

Current period depreciation on the building housing R and D activities 1,500,000

Current period depreciation on a machine used in R and D activities 500,000
Salary of R and D director 1,200,000
Salary of Vice-President who spends ¼ of his time overseeing R and D activities
(2.4M*1/4) 600,000
Pension costs for salary of R and D director 50,000
Pension costs for salary of Vice-President (100T *1/4) 25,000
R & D expense 3,875,000

4. Ipipilit Company purchased a patent from the inventor, who asked P110,000 for it. Ipipilit paid for the patent as follows:
cash, P40,000; issuance of 1,000 shares of its own ordinary shares, par P10 (market value, P20 per share); and a note
payable due at the end of three years, face amount, P50,000, noninterest-bearing. The current interest rate for this type
of financing is 12 percent. Ipipilit Company should record the cost of the patent at ________________.

Cash 40,000
Shares (1Tx20) 20,000
Note (50000x0.7118) 35,590
Cost of Patent 95,590

Patent 95,590
Discount on NP 14,410
Cash 40,000
SC 10,000
 SP 10,000
Notes payable 50,000

5. Sayo Enterprises Inc. developed a new machine for manufacturing baseballs. Because the machine is considered very valuable,
the company had it patented. The following expenditures were incurred in developing and patenting the machine.

Purchases of special equipment to be used solely for development of the new machine
P1,820,000
Research salaries and fringe benefits for engineers and scientists 171,000
Cost of testing prototype 236,000
Legal costs for filing for patent 127,000
Fees paid to government patent office 25,000
Drawings required by patent office to be filed with patent application 47,000

Sayo elected to amortize the patent over its legal life. At the beginning of the second year, Sayo Enterprises paid P240,000 to
successfully defend the patent in an infringement suit. At the beginning of the fourth year Sayo determined that the remaining
estimated useful life of the patent was five years.

The carrying amount of the patent at the end of fourth year is _____________________.

Legal costs for filing for patent 127,000

Fees paid to government patent office 25,000
Drawings required by patent office to be filed with patent application 47,000
Total Cost of Patent 199,000

Patent 199,000
Less: Accumulated Amortization
1st yr 9,950
2nd yr 9,950
3rd yr 9,950 29,850
CA of Patent - end of 3rd yr 169,150
Less: Amortization - 4th yr (169750/5) 33,830
CA of Patent - end of 4th yr 135,320

Alternative:
199,000*17/20*4/5 135,320

6. An entity purchases a trademark and incurs the following costs in connection with the trademark:

One-time trademark purchase price P100,000

Nonrefundable taxes 5,000
Training sales personnel on the use of the new trademark 7,000
Research expenditures associated with the purchase of the new trademark 24,000
Legal costs incurred to register the trademark 10,500
Salaries of the administrative personnel 12,000

Assuming that the trademark meets all of the applicable initial asset recognition criteria, the entity should recognized an asset in
the amount of _________________.

One-time trademark purchase price P100,000

Nonrefundable taxes 5,000
Legal costs incurred to register the trademark 10,500
Cost of Trademark 115,500

7. Kahit Corp. acquired a fast food franchise for a P50,000 cash down payment and in addition gave a P150,00, one-year,
noninterest-bearing note payable. The implicit interest rate is 12 percent. Kahit also agreed to pay the franchiser P100,000 per
year for the next 10 years for promotional campaigns, accounting, and related services by the franchiser. Kahit should record the
cost of the franchise as: __________________

Cash 50,000
Notes Payable (150T*0.8929) 133,935
Total Cost of Franchise 183,935

8. NA Company purchased a customer database and a formula for a new fuel substitute for diesel fuel for a total of P100,000. NA
Company uses the expected cash flow approach for estimating the fair value of these two intangibles. The appropriate interest
rate is 5%. The potential future cash flows from the two intangibles, and their associated probabilities, are as follows:
 Customer Database:
Outcome 1 - 20% probability of cash flows of P10,000 at the end of each year for 5 years.
Outcome 2 - 30% probability of cash flows of P2,000 at the end of each year for 4 years.
Outcome 3 - 50% probability of cash flows of P200 at the end of each year for 3 years.

Formula:
Outcome 1 - 10% probability of cash flows of P50,000 at the end of each year for 10 years.
Outcome 2 - 30% probability of cash flows of P30,000 at the end of each year for 4 years.
Outcome 3 - 60% probability of cash flows of P10,000 at the end of each year for 3 years.

How much should be recognized as customer database?

database formula
outcome 1 8,659 38,609
outcome 2 2,128 31,914
outcome 3 273 16,339
11,060 86,862

Customer Database (100T*11060/97923) 11,295

Formula (100T*86862/97923) 88,705
9. On January 1, 2019, Lilipad Company had capitalized cost of P10,000,000 for a new computer software product with an
economic life of 4 years. Sales for 2019 for the software product amounted to P4,000,000. The total sales of the software over its
economic life are expected to be P20,000,000. However, the pattern of the future sales from the computer software cannot be
determined reliably. Lilipad should record amortization of computer software in 2019 at..

Cost 10,000,000
Multiply 4/20
Amortization 2,000,000

10. Ang Company incurred costs to develop and produce a routine, low-risk computer software product as follows:

Completion of detail program design P 1,500,000

Cost incurred for coding and testing to establish technological feasibility 500,000
Other coding costs after establishment of technological feasibility 2,500,000
Other testing costs after establishment of technological feasibility 2,000,000
Cost of producing product masters for training materials 3,000,000
Duplication for computer software and training materials from product master 4,000,000
Packaging product 1,000,000

What amount should be capitalized as software cost subject to amortization?

Other coding costs after establishment of technological feasibility 2,500,000

Other testing costs after establishment of technological feasibility 2,000,000
Cost of producing product masters for training materials 3,000,000
Total cost of Software 7,500,000

11. ISIP Industries purchased the net assets of SP Company for P1,300,000. A schedule of the net assets of SP Company, as recorded
on SP Company's books at the time of the acquisition, is as follows:

Assets
Cash P 31,000
Receivables 250,000
Inventory 302,000
Land, buildings, and equipment (net) 350,000
Total assets P933,000

Liabilities
Current liabilities P 90,000
Long-term debt 185,000
Total liabilities P275,000

Net assets (book value) P658,000

The following schedule shows the differences between the recorded costs and market values of the assets of SP Company at the
date of the acquisition:
 Cost Market
Inventory P302,000 P400,000
Land, buildings, & equipment 350,000 390,000
Patents -0- 40,000
Purchased in-process research &
development -0- 300,000
Existing work force -0- 90,000
Totals P652,000 P1,220,000
Liabilities P275,000 P 275,000

Determine the amount of goodwill to be recognized on the acquisition

Purchase price 1,300,000

FV of NA
Cash 31,000
Receivables 250,000
Inventories 400,000
L, B and E 390,000
Patent 40,000
In process R & D 300,000
Total Assets 1,411,000
Total Liability (275,000) 1,136,000
Goodwill 164,000

12. Torete Company engaged your services to compute the goodwill in the purchase of Sayo Company which provided the following:

Net income Net assets

2015 P1,400,000 P 6,000,000
2016 1,600,000 8,000,000
2017 2,000,000 8,800,000
2018 2,200,000 9,200,000
Total P7,200,000 P32,000,000

It is agreed that goodwill is measured by capitalizing excess earnings at 25% with normal return on average net assets at 15%.

How much is the purchase price for Sayo Company?

Average earnings 1,800,000

Less: Normal earnings (32M/4)*.15 (1,200,000)
Excess earnings 600,000
Capitalization rate 25%
Goodwill 2,400,000
FV of NA 9,200,000
Purchases price 11,600,000

13. The owners of Hays Company are planning to sell the business to new interests. The cumulative net earnings for the past 5 years
was P9,500,000. The current value of net assets of Hays Company was P20,000,000. Goodwill is determined by capitalizing
average earnings at 8%. What is the amount of goodwill?

Average earnings (9.5/5) 1,900,000

/ Capitalization rate 8%
Net assets, including goodwill 23,750,000
Less: net assets excluding goodwill 20,000,000
Goodwill 3,750,000

14. We purchased all the outstanding ordinary shares of HUHU Travel Corporation. HUHU has one asset whose value exceeds its
book value by P10,000. HUHU's Equity is P80,000. We agreed with HUHU that its excess earnings would last for 10 years and
we were granted a 10% return on our investment. HUHU's average income for negotiation purposes is P40,000 and the industry
average rate of return is 30% on market value of net assets. Using the "present value of excess earnings" approach to the
calculation of goodwill, what is the purchase price paid for HUHU?

Average earnings 40,000

Less: normal earnings (90000*30%) 27,000
Excess earnings 13,000
 * PVF 6.1446
Goodwill 79,880
FV of NA 90,000
Purchase price 169,880
FV of NA 9,200,000
Purchases price 9,200,000

-- end of Pre-Assessment Activity --

Assessment

1. Online quiz through Canvas.

Optional Activities/Resources

1. Intermediate Accounting 1B 2019 Edition by Zeus Vernon B. Millan

2. https://www.iasplus.com/en/standards/ias/ias2

SMC 😊