FAR SEC 9 Flashcards
What are the six main categories of intangible assets?
1) Marketing-related (e.g., trademarks),
2) Customer-related (e.g., customer lists),
3) Artistic-related (e.g., copyrights),
4) Contract-related (e.g., franchise rights),
5) Technology-related (e.g., computer software), and
6) Goodwill (recognized only in business combinations).
What is the definition of intangible assets? (3 elements)
1) They lack physical substance.
i) In general, intangible assets convey to the holder a contractual or legal right to receive future economic benefits.
ii) Common examples are patents, trademarks, copyrights, and franchise arrangements.
2) They are not financial assets.
i) Intangible assets thus do not include such items as cash, equity investments, accounts and notes receivable, bonds receivable, or prepaid expenses.
3) Because the accounting treatment of goodwill is different from that of other intangible assets, goodwill is discussed in Subunit 9.3.
How does initial recognition of intangible assets occur? (2 elements)
1) Externally acquired intangibles other than goodwill are initially recorded at acquisition cost plus any incidentals such as legal fees.
2) Internally developed intangibles other than goodwill are most often initially recorded at the amount of the incidental costs (e.g., legal fees) only.
-Most of the costs of an internally generated intangible asset consist of research and development (R&D), which must be expensed as incurred.
How are organization and start-up costs for intangible assets treated? (2 elements)
1) Organization costs are those incurred in the formation of a business entity. They include payments to promoters, legal and accounting fees, and costs of registering with the state of incorporation.
2) For financial accounting purposes, nongovernmental entities must expense all start-up and organization costs as incurred.
What is the useful life of an asset?
The useful life of an asset is the period during which it is expected to contribute either directly or indirectly to the future cash flows of the reporting entity.
How are intangible assets having a finite useful life treated?
An intangible asset with a finite useful life to the reporting entity is amortized over that useful life.
-The useful life should be reevaluated each reporting period. A change in the estimate results in a prospective change in amortization.
How are intangible assets with a finite useful life amortized? (2 elements)
1) Amortization is based on the pattern of consumption of economic benefits, if reliably determinable. Otherwise, the straight-line method must be used.
2) The amortizable amount 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
i) A third party has committed to purchase the asset, or
ii) 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.
What happens to an intangible asset with an indefinite useful life?
An intangible asset with an indefinite useful life is not amortized.
What happens if an asset once determined to have a finite useful life is later to determined to have an indefinite useful life? (2 elements)
If an amortized intangible asset is later determined to have an indefinite useful life, it must (1) no longer be amortized and (2) be tested for impairment.
How is the carrying amount of an intangible asset determined? (3 elements)
1) The carrying amount of an intangible asset is the amount at which it is reported in the financial statements.
2) The carrying amount of an intangible asset with a finite useful life equals its historical cost minus accumulated amortization and impairment losses.
3) The carrying amount of an intangible asset with an indefinite useful life equals its historical cost minus impairment losses.
How is an intangible asset with finite useful life tested for impairment? (3 elements)
1) An intangible asset with a finite useful life (an amortized intangible asset) is reviewed for impairment when events or changes in circumstances indicate that its carrying amount may not be recoverable.
2) The test for impairment is the same as the test for long-lived tangible assets described in Study Unit 8, Subunit 8. It is a two-step test:
i) Recoverability test. The carrying amount is not recoverable if it exceeds the sum of the undiscounted future cash flows expected from the use and disposition of the asset.
ii) If the carrying amount is not recoverable, an impairment loss may be recognized. It equals the excess of the carrying amount of the asset over its fair value.
-An impairment loss is recognized in income from continuing operations.
3) The carrying amount of an intangible asset adjusted for an impairment loss is its new cost basis. A previously recognized impairment loss must not be reversed.
What is shown on the table for Determination of Impairment Loss (finite life intangible asset)? (3 elements)
How is an intangible asset with indefinite useful life tested for impairment? (3 elements)
1) An intangible asset with an indefinite useful life (a nonamortized intangible asset) must be reviewed for impairment at least annually. It is tested more often if events or changes in circumstances suggest that the asset may be impaired. An entity may perform a qualitative assessment prior to determining whether it is necessary to perform the quantitative impairment test. The performance of the qualitative assessment is at the discretion of the entity. The entity may decide to bypass the qualitative assessment and directly perform the quantitative test.
2) Qualitative assessment. After the assessment of qualitative factors, the entity may determine that it is more likely than not (probability > 50%) that an indefinite-lived intangible asset is not impaired. In this case, the quantitative impairment test is not required. If potential impairment is found, the quantitative impairment test must be performed.
3) Quantitative assessment. The carrying amount of an asset is compared with its fair value. If the carrying amount exceeds the fair value, the asset is impaired, and the excess is the recognized loss.
-This loss also is nonreversible, so the adjusted carrying amount is the new accounting basis.
What is shown on the table for Determination of an Impairment Loss (intangible assets with indefinite life)? (2 elements)
What is the accounting treatment of patents? (4 elements)
1) Patents may be purchased or developed internally.
i) The initial capitalized cost of a purchased patent is normally the fair value of the consideration given, that is, its purchase price plus incidental costs, such as registration and attorneys’ fees.
ii) Internally developed patents are less likely to be capitalized because related R&D costs must be expensed when incurred.
-Thus, only relatively minor costs can be capitalized, for example, patent registration fees and legal fees.
2) The amortization period for a patent is the shorter of (1) its useful life or (2) the legal life remaining after acquisition or the moment the application was filed.
-The useful life may be substantially shorter than the legal life because of (a) changes in consumer tastes, (b) delays in marketing the product or service, and (c) development of substitutes or improvements.
3) The accounting treatment of the costs of the legal defense of a patent depends upon the outcome of the litigation.
i) The 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.
ii) The costs of unsuccessful litigation (damages, attorneys’ fees) are expensed as incurred.
-An unsuccessful suit also indicates that the unamortized cost of the patent has no value and should be recognized as a loss.
4) Patents may be sold or temporarily licensed. A license of a patent is considered a license of functional intellectual property (IP). Other common examples of functional IP are a software license, a drug formula, and completed media content (e.g., films or music).
-Revenue from a license of the right to use the functional IP is recognized at the point in time at which the license is granted (but not before the customer can benefit from the license).
How are royalties from licensed intellectual property treated?
Revenue for sales-based or usage-based royalties from licensed IP (both functional and symbolic IP) is recognized when (or as) the later of the following occurs:
i) The subsequent sale or usage occurs.
ii) The entity satisfied the performance obligations to which the sales-based or usage-based royalty relates.
What is the definition of goodwill? (3 elements)
1) Goodwill is recognized only in a business combination. It is “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized” (ASC 350-20-20).
2) Internally generated goodwill must not be recognized in the financial statements. Study Unit 14 covers the accounting for the initial recognition of goodwill.
3) Goodwill is not amortized. Instead, goodwill of a reporting unit is tested for impairment each year at the same time.
What is the impairment test for goodwill? (5 elements)
1) Goodwill is tested for impairment at the reporting unit level. All goodwill is assigned to the reporting units that will benefit from the business combination.
Different reporting units may be tested at different times.
2) A reporting unit is an operating segment or one of its components (one level of reporting below an operating segment).
3) As with the impairment test of other intangible assets with indefinite useful lives, an entity may first perform a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test.
4) Qualitative assessment. The entity may choose to assess whether qualitative factors indicate that it is more likely than not (probability > 50%) that the fair value of the reporting unit is less than its carrying amount.
i) The qualitative assessment considers relevant events and circumstances. Among many others, they may include (a) macroeconomic, industry, and market conditions; (b) cost increases; (c) overall financial performance; (d) other entity-specific events; and (e) events affecting the reporting unit.
ii) The quantitative test need not be performed if the qualitative assessment does not indicate impairment.
5) If the qualitative assessment indicates that potential impairment exists, the quantitative impairment test below is performed to determine whether goodwill is impaired.
i) The fair value of the reporting unit is compared with its carrying amount, including goodwill.
ii) A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value. The loss is limited to the total amount of goodwill allocated to that reporting unit. The journal entry is as follows:
Impairment loss $XXX
Goodwill $XXX
iii) The goodwill impairment loss is recognized in the income statement and cannot be reversed in subsequent periods.
How is goodwill treated in private company accounting? (4 elements)
1) A private company is any entity that is not (1) a public business entity, (2) a not-for-profit entity, or (3) an employee benefit plan.
In accounting for subsequent measurement of goodwill, a private company may
i) Use the FASB codification guidance that applies to all entities (the accounting treatment described above) or
ii) Elect to apply the goodwill accounting alternative.
2) Under the accounting alternative, goodwill must be amortized on a straight-line basis over a 10-year period. The amortization expense is recognized in the income statement.
i) The amortization period for goodwill cannot exceed 10 years.
ii) A private company may amortize goodwill over a period shorter than 10 years if it can demonstrate that this useful life is more appropriate.
3) The goodwill impairment test under the accounting alternative is the same as under the general FASB codification guidance except that goodwill
i) Can be tested for impairment on an entity level and
ii) Is tested for impairment only when a triggering event occurs indicating that the fair value of the entity is below its carrying amount. A triggering event evaluation must be performed only at the end of each reporting period.
4) NOTE: Unless specifically stated otherwise, all questions and simulations are based on the FASB codification guidance applied to all entities. The guidance for private companies should be used only when the facts of a question or simulation state that a private company has elected the accounting alternative.
How is goodwill presented in the financial statements? (2 elements)
1) In the balance sheet, intangible assets are required to be presented, at a minimum, as a single aggregated line item. But individual intangible assets or classes of these assets may be separately presented.
-Goodwill is presented in the aggregate as a separate line item.
2) In the income statement, amortization expense and impairment losses related to intangible assets are presented as line items under continuing operations.
What is a franchise? (2 elements)
1) A franchise is a contractual agreement by a franchisor (grantor of the franchise) to permit a franchisee (purchaser) to operate a certain business.
2) Thus, an exclusive right may be granted to sell a specified product or service in a given geographical area and to use trademarks, patents, trade secrets, etc.
How is franchisee accounting done? (3 elements)
1) The franchisee should capitalize the costs of acquiring the franchise. The capitalizable amount includes the initial fee and other expenditures (e.g., legal fees) necessary to acquire the franchise that will provide future benefits.
-If the initial fees are paid over a period longer than 1 year, the present value of the payments is capitalized as part of franchise costs and recognized as an intangible asset.
2) Franchise costs (the amounts capitalized) are amortized over their estimated useful life if such life is finite.
3) Future payments based on a percentage of revenues or for franchisor services are expensed as incurred. They benefit only the period of payment.
How is franchisor accounting done? (3 elements)
1) A franchise right is considered symbolic intellectual property (IP). Other common examples of symbolic IP are trade names, brands, and logos. Revenue from a license of the right to access symbolic IP is recognized over time. Thus, franchise fee revenue is recognized over the franchise license period (or over its remaining economic life, if shorter).
2) Revenue from initial fixed fees received generally is recognized evenly over the entire franchise license period.
3) Revenue from sales-based royalties typically is recognized when the sales occur.
How are research and development (R&D) costs expensed? (3 elements)
1) Research and development (R&D) costs must be expensed as incurred.
2) This rule does not apply to R&D activities conducted for others.
3) This rule also does not apply to assets (tangible or intangible) acquired in a business combination that are used in R&D activities. Such assets are initially recognized and measured at fair value even if they have no alternative use.
What is research?
Research is planned search or critical investigation aimed at discovery of new knowledge with the hope that it will be useful in developing a new (or significantly improving an existing) product, service, process, or technique (product or process).
What is development? (3 elements)
1) Development is translation of research findings or other knowledge into a plan or design for a new or improved product or process.
2) It includes conceptual formulation, design, and testing of product alternatives; prototype construction; and operation of pilot plants.
3) Development does not include routine alterations to existing products, production lines, processes, and other ongoing operations.
-Market research or testing also is excluded.
What are the main examples of R&D activities? (9 elements)
The following are examples of activities typically included in R&D unless conducted for others under a contract (reimbursable costs are not expensed):
1)Laboratory research aimed at discovery of new knowledge
2) Searching for applications of new research findings or other knowledge
3) Conceptual formulation and design of possible product or process alternatives
4) Testing in search for, or evaluation of, product or process alternatives
5) Modification of the formulation or design of a product or process
6) Design, construction, and testing of preproduction prototypes and models
7) Design of tools, jigs, molds, and dies involving new technology
8) Design, construction, and operation of a pilot plant that is not of a scale economically feasible to the entity for commercial production
9) Engineering activity required to advance the design of a product until it meets specific functional and economic requirements and is ready for manufacture
What are the main examples of activities that are NOT classified as R&D? (9 elements)
The following are examples of activities that typically are not classified as R&D:
1) Engineering follow-through in an early phase of commercial production
2) Quality control during commercial production, including routine testing of products
3) Troubleshooting in connection with breakdowns during commercial production
4) Routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of an existing product
5) Adaptation of an existing capability to a particular requirement or customer’s need as part of a continuing commercial activity
6) Seasonal or other periodic design changes to existing products
7) Routine design of tools, jigs, molds, and dies
8) Activity, including design and construction engineering, related to the construction, relocation, rearrangement, or start-up of facilities or equipment other than pilot plants and facilities or equipment whose sole use is for a particular R&D project
9) Legal work in connection with patent applications or litigation and the sale or licensing of patents
What are the elements of R&D costs? (6 elements)
1) Materials, equipment, and facilities. The costs of such items acquired or constructed for R&D and having alternative future uses (in R&D projects or otherwise) are capitalized as tangible assets and depreciated over their estimated useful lives.
i) The costs of materials consumed in R&D and the depreciation of equipment or facilities used in R&D are R&D costs and are expensed when incurred.
ii) The costs of materials, equipment, or facilities acquired (but not in a business combination) or constructed for a particular project and having no alternative future uses (and no separate economic values) are R&D costs and are expensed when incurred.
2) Personnel. Salaries, wages, and other related costs of personnel engaged in R&D are included in R&D costs and are expensed when incurred.
3) Intangible assets purchased from others. These costs of R&D assets having alternative future uses are capitalized as intangible assets. They are amortized if their useful lives are finite.
i) The amortization of those intangible assets is an R&D cost.
ii) The costs of intangible assets purchased from others (but not in a business combination) for a particular project and having no alternative future uses (and no separate economic values) are R&D costs and are expensed when incurred.
4) Contract services. The costs of services performed by others in connection with the R&D activities of an entity, including R&D conducted by others on behalf of the entity, are R&D costs and are expensed when incurred.
5) Indirect costs. R&D costs include a reasonable allocation of indirect costs, which also are expensed.
-General and administrative costs not clearly related to R&D are excluded.
6) Disclosure is made in the financial statements of the total R&D costs charged to expense in each period for which an income statement is presented.
How is R&D funded by others treated? (3 elements)
1) Sometimes an entity’s R&D is funded wholly or partly by others.
2) If the entity is obligated to repay any of the funds provided by the other party regardless of the outcome of the project, it recognizes a liability.
3) If repayment depends solely on the results of the R&D having future economic benefit, the entity accounts for its obligation as a contract to perform R&D for others.
What is the key factor determining how software is treated for accounting purposes?
Accounting for the costs of developing or obtaining computer software depends on whether the software is (1) sold to external customers or (2) used internally.
What are the two possible accounting treatments for software, and how do they work? (3 elements)
1) Accounting for the costs of developing or obtaining computer software depends on whether the software is (1) sold to external customers or (2) used internally.
2) Costs of software may be
Expensed as incurred,
Capitalized as computer software costs, or
Included in inventory.
3) Costs of software to be used internally are either expensed or capitalized.
For software to be marketed, how are costs expensed? (2 elements)
1) Costs incurred before technological feasibility is established (coding, testing, etc.) are expensed as incurred. Thus, they are treated as R&D costs.
2) Technological feasibility is established when either a detailed program design is complete or the entity has created a working model.
For software to be marketed, how are costs capitalized? (3 elements)
1) Costs incurred after technological feasibility is established (coding, testing, producing product masters) are capitalized as computer software costs.
2) Amortization begins and capitalization ends when the product is available for general release.
3) If purchased software to be marketed has no alternative future use, the entity accounts for its cost as if it had been developed internally to be marketed. If purchased software to be marketed has an alternative future use, the entity capitalizes the costs when it purchases the software and accounts for it according to use.
For software to be marketed, what costs are included in inventory?
Costs incurred to prepare the product for sale (duplication of software, training materials, packaging) are capitalized as inventory.
What is shown on the Costs of Software to Be Marketed diagram?
For software to be marketed, how is the annual amortization of capitalized software costs treated? (3 elements)
1) Annual amortization is the greater of
2) Total capitalized cost times the revenue ratio (Annual gross software revenue ÷ Total projected gross revenue) or
3) Straight-line amortization (Total capitalized cost ÷ Estimated economic life of the software).
For software to be marketed, how is balance sheet measurement treated? (3 elements)
Capitalized software costs are reported at the lower of unamortized cost or net realizable value (NRV).
A loss on the write-down to NRV is recognized in the income statement. After the write-down, the carrying amount of computer software is the new cost basis.
The amount of the write-down to NRV must not be subsequently restored.
For software to be used internally, how are costs expensed? (2 elements)
1) Costs incurred during the preliminary project stage (planning, evaluation) are expensed as incurred.
2) Costs incurred for training and maintenance are also expensed.
For software to be used internally, how are costs capitalized? (2 elements)
1) Costs incurred during the application development stage (coding, testing) are capitalized as computer software costs. They include
i) External direct costs of materials and services,
ii) Payroll costs directly associated with the project, and
iii) Interest costs associated with the project.
2) When software is replaced, unamortized costs of the old software are expensed.
For software to be used internally, how is amortization treated?
Annual amortization of the capitalized costs of software to be used internally is on a straight-line basis over the estimated economic life of the software.
For software to be used internally, how is subsequent sale treated? (3 elements)
1) Occasionally, software developed for internal use is sold to outside parties.
2) The net proceeds from these sales reduce the carrying amount of capitalized software costs.
3) When the carrying amount is $0, net proceeds are recognized as revenue.
What are the two “other issues” pertaining to prepayments?
1) An asset provides future economic benefits. If a cash payment is made in one period and the recognition of the related expense (receipt of the benefit) is not appropriate until a later period, the deferred cost is recorded as an asset.
i) Examples include prepaid insurance, rent, interest, and income taxes.
ii) The amount of the prepaid expense that will be used up within the longer of 1 year or the next operating cycle of the entity is classified as a current asset.
2) Adjusting entries are made as of the balance sheet date to record the effects on periodic revenue and expense of deferrals (prepaid expenses) and accruals. The adjusting journal entry recorded depends on how the original transaction was initially recorded.
i) If the payment is initially recorded as an asset (prepaid expenses), the year-end adjusting entry credits the asset and debits an expense for the expired portion.
ii) If the payment is initially recorded as an expense, the year-end adjusting entry debits an asset (prepaid expenses) and credits (decreases) expense for the unexpired portion.
