9.2 Flashcards
On July 1, Year 1, Roxy Co. obtained fire insurance for a 3-year period at an annual premium of $72,000 payable on July 1 of each year. The first premium payment was made July 1, Year 1. On October 1, Year 1, Roxy paid $24,000 for real estate taxes to cover the period ending September 30, Year 2. The prepayment was made to obtain a discount. In its December 31, Year 1, balance sheet, Roxy should report prepaid expenses of
$54,000.
The entity prepaid an insurance premium for 12 months on July 1. It prepaid taxes on October 1 for 12 months. Accordingly, 50% of the insurance and 25% of the tax prepayment had expired at December 31. The year-end prepaid expense balance is therefore $54,000 [($72,000 × 50%) + ($24,000 × 75% )].
Which of the following legal fees should be capitalized?
Legal fees to obtain a franchise:
Legal fees to successfully defend a trademark:
Yes
Yes
Intangible assets acquired other than in a business combination are initially recognized and measured based on their fair value. This “cost” should be based on the more reliably measurable of the fair value of the consideration given or the fair value of the assets acquired. Thus, legal fees to obtain an intangible asset are part of its cost. Legal fees incurred in the successful defense of an intangible asset also should be capitalized as part of its cost. A franchise is a contract right and a trademark is a device, such as a word, that identifies the origin or ownership of a product and is legally reserved to the exclusive use of the owner. Both are therefore intangible assets because they are nonfinancial assets without physical substance, and both should be capitalized.
On January 2, Year 1, Gant Co. purchased a franchise with a useful life of 5 years for $60,000 and an annual fee of 1% of franchise revenues. Franchise revenues were $20,000 during Year 1. Gant projects future revenues of $40,000 in Year 2 and $60,000 per year for the following 3 years. Gant uses the straight-line method of amortization. What amount should Gant report as intangible asset-franchise, net of related amortization in its December 31, Year 1, balance sheet?
$48,000.
The franchisee should capitalize the costs of acquiring the franchise. The capitalization amount includes the initial fee and other expenditures, e.g., legal fees, necessary to acquire the franchise that will provide future benefits. Future payments based on a percentage of revenues or for franchisor services are expensed as incurred. They only benefit the period of payment. Franchisee cost is amortized over its estimated useful life if such a life is finite. Gant must amortize the $60,000 cost over 5 years, for a total amortization of $12,000 per year. The 1% fee paid is expensed each year. Hence, the carrying amount of the asset net of amortization is $48,000.
Cody Corp. incurred the following costs during Year 1:
Design of tools, jigs, molds, and dies involving new technology: $125,000
Modification of the formulation of a process: 160,000
Trouble-shooting in connection with break- downs during commercial production: 100,000
Adaptation of an existing capability to a particular customer’s need as part of a continuing commercial activity: 110,000
In its Year 1 income statement, Cody should report research and development expense of
$285,000
In general, R&D is a planned search for new knowledge in the hope of developing new or significantly improved products and processes or a translation of knowledge into plans or designs for new or significantly improved products or processes. Examples of R&D activities include (1) the design of tools, jigs, molds, and dies involving new technology, and (2) the modification of the formulation of a process. Examples of activities that are not R&D include (1) trouble-shooting in connection with breakdowns and (2) adaptation of an existing capability to a particular customer’s needs as part of a continuing commercial activity. Thus, Cody should report R&D expense of $285,000 ($125,000 + $160,000) in its Year 1 income statement.
After an impairment loss is recognized, the adjusted carrying amount of the intangible asset shall be its new accounting basis. Which of the following statements about subsequent reversal of a previously recognized impairment loss is correct?
It is prohibited.
When an impairment of an intangible asset is recognized, the previous carrying amount of the asset is reduced by the impairment loss. The adjusted carrying amount is the new accounting basis. Thus, it cannot be increased subsequently for a change in fair value. This rule applies whether the intangible asset has a finite or an indefinite useful life.
During the current year, Beta Motor Co. incurred the following costs related to a new solar-powered car:
Salaries of laboratory employees researching how to build the new car: $250,000
Legal fees for the patent application for the new car: 20,000
Engineering follow-up during the early stages of commercial production (the follow-up occurred during the current year): 50,000
Marketing research to promote the new car: 30,000
Design, testing, and construction of a prototype: 400,000
What amount should Beta Motor report as research and development expense in its income statement for the current year?
$650,000.
Salaries, wages, and other related costs of personnel engaged in R&D and the design, construction, and testing of preproduction prototypes and models are activities typically included in R&D. These costs are expensed when incurred. Thus, R&D expense for the current year is $650,000 ($250,000 + $400,000).
Standard Co. spent $10,000,000 on its new software package that is to be used only for internal use. The amount spent is for costs after the application development stage. The economic life of the product is expected to be 3 years. The equipment on which the package is to be used is being depreciated over 5 years. What amount of expense should Standard report on its income statement for the first full year?
$3,333,333
Amortization of the costs of computer software developed or obtained for internal use should be on a straight-line basis over the useful life of the software unless another systematic and rational basis is more representative. Thus, Standard’s amortization expense for the first full year is $3,333,333 ($10,000,000 ÷ 3 years).
In accordance with generally accepted accounting principles, which of the following methods of amortization is required for amortizable intangible assets if the pattern of consumption of economic benefits is not reliably determinable?
Straight line.
The default method of amortization of intangible assets is the straight-line method.
Wizard Co. purchased two machines for $250,000 each on January 2. The machines were put into use immediately. Machine A has a useful life of 5 years and can be used in only one research project. Machine B will be used for 2 years on a research and development project and then used by the production division for an additional 8 years. Wizard uses the straight-line method of depreciation. What amount should Wizard include in research and development expense for the year?
$275,000.
The costs of equipment acquired or constructed for a particular project and having no alternative future uses and therefore no separate economic values are R&D costs and are expensed when incurred. The costs of equipment acquired for R&D and having alternative future uses are capitalized as tangible assets when acquired or constructed. Thus, Machine A should be expensed and Machine B should be capitalized. The cost to include in R&D relating to Machine A is $250,000, the entire cost of the machine. The cost to be included in R&D relating to Machine B is the straight-line depreciation of $25,000 ($250,000 ÷ 10). Total R&D expense for the machines used is $275,000 ($250,000 + $25,000).
During the current year, Lyle Co. incurred $204,000 of research and development costs in its laboratory to develop a patent that was granted on July 1. Legal fees and other costs associated with registration of the patent totaled $41,000. The estimated useful life of the patent is 10 years. What amount should Lyle capitalize for the patent on July 1?
$41,000.
R&D costs are required to be expensed as they are incurred. Legal fees and registration fees are excluded from the definition of R&D. Thus, the $41,000 in legal fees and other costs associated with the registration of the patent should be capitalized. The $204,000 in R&D costs should be expensed.
West Co. paid $50,000 for an intangible asset other than goodwill. Fair value of the asset is $55,000. West signed a contract to sell the asset for $10,000 in 10 years. What amount of amortization expense should West record each year?
$4,000.
An intangible asset with a finite useful life to the reporting entity is amortized over that useful life. Amortization is based on the pattern of consumption of economic benefits, if reliably determinable. Otherwise, the straight-line method must be used. Thus, this intangible asset is amortized over 10 years using the straight-line amortization method. The amortizable amount of an intangible asset equals the amount initially assigned minus the residual value. The residual value is the estimated fair value to the entity at the end of the asset’s useful life minus disposal costs. This amount is zero unless (1) a third party has committed to purchase the asset or (2) it can be determined from an exchange transaction in an existing market for the asset that is expected to exist at the end of the useful life. Thus, the amortizable amount of the intangible asset is $40,000 ($50,000 historical cost – $10,000 residual value), and the annual amortization expense is $4,000 ($40,000 amortizable amount ÷ 10 years).
Ala Company acquired Mish Company on January 1, Year 1. A goodwill of $480,000 was recognized on this acquisition. Ala is a private company, and it applies the accounting alternative to account for goodwill recognized in this business combination. The synergies expected from combining the operations of the two businesses are estimated to last over the next 20 years. However, due to Ala expecting to discontinue some of the activities of Mish in the future, Ala estimates that the useful life of goodwill is 14 years. Over how many years, if at all, should the goodwill recognized be amortized by Ala?
10.
A private company may elect the accounting alternative for accounting for goodwill. Under the goodwill accounting alternative, goodwill recognized must be amortized on a straight-line basis over 10 years. A private company may amortize goodwill over a period shorter than 10 years if it can demonstrate that this useful life is more appropriate. However, the amortization period of goodwill cannot exceed 10 years.
On January 2, Fafnir Co. purchased a franchise with a finite useful life of 10 years for $50,000. An additional franchise fee of 3% of franchise operation revenues must be paid each year to the franchisor. Revenues from franchise operations amounted to $400,000 during the year, and the pattern of consumption of benefits of the franchise is not reliably determinable. In its December 31 balance sheet, what amount should Fafnir report as an intangible asset-franchise?
$45,000.
Intangible assets acquired other than in a business combination are initially recognized and measured based on their fair value. This “cost” should be based on the more reliably measurable of the fair value of the consideration given or the fair value of the assets acquired. Franchise fees are capitalized and amortized over the finite useful life. Absent information about the fair value of the assets acquired, the capitalizable amount equals the consideration given, that is, the initial fee and other expenditures necessary to acquire the franchise. Future franchise fees are expensed as incurred. Given that the pattern of consumption of benefits of the franchise is not reliably determinable, the straight-line method of amortization is used. Thus, given no residual value, the amount that should be reported as an intangible asset is $45,000 [$50,000 – ($50,000 ÷ 10)].
Brill Co. made the following expenditures during Year 1:
Costs to develop computer software for internal use in Brill’s general management information system: $100,000
Costs of market research activities: 75,000
What amount of these expenditures should Brill report in its Year 1 income statement as research and development expenses?
$0.
Costs of market research are not R&D costs. Furthermore, general and administrative costs not clearly related to R&D activities are not included as R&D costs. Thus, costs to develop software for the company’s own general management information system are also not R&D costs.
Grayson Co. incurred significant costs in defending its patent rights. Which of the following is the appropriate treatment of the related litigation costs?
Litigation costs would be capitalized if the patent right is successfully defended.
Subsequent to the grant of a patent, its owner may need to bring or defend a suit for patent infringement. The unrecovered costs of successful litigation are capitalized because they will benefit future periods. They are amortized over the shorter of the remaining legal life or the estimated useful life of the patent. The costs of unsuccessful litigation (damages, attorneys’ fees) are expensed. An unsuccessful suit also indicates that the unamortized cost of the patent has no value and should be recognized as a loss.
