APPLIED AUDITING PROBLEMS AP.05 - Audi Au di t o f In tangi tan gi ble bl e Ass ets
SMC
SUBSTANTIVE AUDIT OF INTANGIBLE ASSETS Existence: Recorded intangible intangible assets exist 1.
2.
Valuation and allocation: allocation: accordance with GAAP
Obtain an analysis of ledger accounts for intangible assets.
6.
Vouch additions to or acquisitions during the year.
Examine documentation supporting intangible assets.
7.
Evaluate dispositions and write offs during the year.
8.
Evaluate amortization policy and verify computation of amortization.
Completeness: All intangible intangible assets are recorded 3. 4.
Vouch additions to or acquisitions during the year. Presentation and disclosure: disclosure: Intangible assets are classified and disclosed in accordance with GAAP
Evaluate dispositions and write offs during the year.
9.
Rights and obligations: obligations: Intangible assets are are owned by the entity 5.
Intangible assets are valued in in
Review financial statements and perform analytical procedures to determine whether accounts are classified and disclosed in the financial statements in accordance with GAAP.
Examine documentation supporting intangible assets.
INTERNAL CONTROL MEASURES 1.
Acquisitions, dispositions dispositions and write write offs of intangible intangible assets should be properly authorized. authorized.
2.
Adequacy and consistency of of accounting policies governing intangible assets should be reviewed periodically.
3. General ledger account should be supported by adequate detailed records and they should be periodically reconciled. 4.
Schedules of intangibles showing showing their cost and basis of amortization should be prepared periodically and reviewed by a responsible official. - end -
PROBLEM NO. 1
Apr.1
The accountant of the newly organized Zerg Corporation provided to you the details the company’s Intangible Assets account as follows:
Date 01/02 01/15 04/01 05/01 07/01 12/31
Intangible Assets Description Organization costs Goodwill Patent Li cense and trademark R & D laboratory Product development costs
Amount P 233,000 15,000 490,000 300,000 1,310,000 1,750,000 P4,098,000
Patented a newly developed process with costs as follows: Legal fees to obtain patent Patent application and licensing fees Total
P429,000 61,000 P490,000
It is estimated that in 5 years other companies will have developed improved processes, making the Zerg Corporation process obsolete. May1
Acquired both a license to use a special type type of container and a distinctive trademark to be printed on the container in exchange for 6,000, no-par, ordinary shares of Zerg selling for P50 per share. The license is worth twice as much as the trademark, both of which may be used for 5 years.
Transactions during 2012 included the following: Jan.2
Paid legal legal fees of P150,000 and stock stock certificate certificate costs of P83,000 to complete organization of the corporation.
Jul. 1
Constructed a shed for P1,310,000 to house prototypes of experimental models to be developed in future research projects.
15
Hired a clown to stand in front of the corporate office for 2 weeks and hand out pamphlets and candy to create goodwill for the new enterprise. Clown cost, P10,000; pamphlets and candy, P5,000.
Dec. 31
Paid salaries for an engineer and chemist involved in research and development totaling P1,750,000 in 2012.
It is the company’s policy to take full year amortization in the year of acquisition.
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4. REQUIRED 1.
Prepare the necessary adjusting adjusting journal entries as of December 31, 2012.
2.
Compute the carrying carrying amount amount of the Intangible Intangible assets as of December 31, 2012.
Carrying amount amount of other intangible assets on December December 31, 2012 a. P690,000 c. P980,000 b. P640,000 d. P706,667
PROBLEM NO. 3
3.
Compute the total total amount resulting from the foregoing foregoing transactions that should be expensed when incurred.
You noted the following items relative to the company’s Intangible assets in connection with your audit of the Five Corporation’s financial statements for the year 2012. Franchise
PROBLEM NO. 2 The Terran Company acquired Company acquired several small companies at the end of 2011 and, based on the acquisitions, reported the following intangibles in its December 31, 2011 statement of financial position: Patent Copyright Tradename Computer software Goodwill
P200,000 400,000 350,000 100,000 900,000
The company's accountant determines the patent has an expected life of 10 years and no e xpected residual value, and that it will generate approximately equal benefits each year. The company expects to use the copyright and tradename for the foreseeable foreseeable future. future. The accountant accountant knows knows that the computer software is used in the company's 120 sales offices. The company has replaced the software in 60 offices in 2012, and expects to replace the software in 40 more offices in 2013 and the remainder in 2014. On December 31, 2012, there are no indications of impairment of patent and computer computer software. software. The following information relate to the other intangible assets: a) Because of the rampant rampant piracy, the copyright copyright is expected to generate cash flows of just P8,000 per year. b) The tradename tradename is expected to generate cash flows of P15,000 per year. c)
The goodwill is associated with Terran’s SCV Manufacturing reporting reporting unit. The cash flows flows expected to be generated by the SCV Manufacturing reporting unit is P200,000 per year year for the next 25 years. The reporting unit has a carrying amount of P2,100,000.
On January 1, 2012, Five sig ned an agreement to operate as franchisee of Clear Copy Service, Inc. for an initial franchise of P680,000. Of this amount, amount, P200,000 was was paid when the agreement was signed and the balance was payable in four annual payments of P120,000 each, beginning January 1, 2013. The agreement agreement provides that the down down payment payment is not refundable and no future services are required of the franchisor. The implicit rate rate for loan of this this type is 14%. The agreement also provides the 5% of the revenue from the franchise must must be paid to the franchisor annually. Five’s revenue from the franchise for 2012 was P8,000,000. P8,000,000. Five estimates the useful life of the franchise to be ten years. Patent On July 1, 2012, Five purchased a patent from the inventor, who asked P1,100,000 P1,100,000 for it. Five paid for the patent as follows: cash, P400,000; issuance of 10,000 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, P500,000, noninterest-bearing. noninterest-bearing. The current interest rate for this type of financing is 12 percent. percent. Five estimates estimates the useful life of the patent to b e ten years. Trademark Five purchased for P1,200,000 a trademark for a very successful soft drink it markets under the name POWER!. The trademark was was determined to have an indefinite life. A competitor recently introduced a product that is in direct competition with the POWER! product, thus suggesting the need for an impairment test. Data gathered gathered by the entity suggests that the useful life of the trademark is still indefinite, but the cash flows expected to be generated by the trademark have been reduced either to P40,000 per year (with a probability of 70%) or to P80,000 per year (with 30% probability). The appropriate risk-free risk-free interest rate is 5%. The appropriate risk-adjusted interest rate is 10%.
QUESTIONS: QUESTIONS: Based on the above and the result of your audit, determine the following: (Assume that the appropriate discount rate for all items is 5%) 1.
2.
3.
Based on the above and the result of your audit, determine the following: (Round off present value factors to 4 decimal places)
Total amortization of intangible assets assets in 2012 a. P 70,000 c. P88,750 b. P107,500 d. P20,000
1.
Total expenses related to franchise in 2012 a. P503,914 c. P448,950 b. P535,200 d. P454,964
Total loss on impairment in 2012 a. P452,470 b. P530,280
2.
Carrying amount of franchise as of December 31, 2012 a. P549,644 c. P538,733 b. P494,680 d. P612,000
3.
Carrying amount of patent as of December 31, 2012 a. P1,045,000 c. P860,310 b. P 955,900 d. P908,105
c. P471,220 d. P433,720
Carrying amount of goodwill on December December 31, 2012 a. P900,000 c. P855,000 b. P718,780 d. P659,720
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4.
Total expenses related to the intangible assets in 2012 a. P662,759 c. P733,063 b. P711,709 d. P802,212
PROBLEM NO. 4 Summer Manufacturing Corporation was incorporated on January 3. 2013. The corporation’s financial statements for its first year’s operations were not examined by a CPA. You have been engaged to audit the financial statements for the year ended December 31, 2014, and your work is substantially completed. A partial trial balance of the company’s accounts follows: Account Title Title Cash Accounts Receivable Allowance for doubtful accounts accounts Inventories Machinery Equipment Accumulated depreciation Patent (Item 1) Leasehold improvement (Item 6) Prepaid expenses Organization expenses (Item 7) Goodwill (Item 5) Licensing Agreement Agreement – – A* A* (Item 2 & 3) Licensing Agreement Agreement – – B* B* (Item 2 & 4)
Debit P11,000 42,500
Credit
P500 38,500 75,000 29,000
Item 6: The Leasehold Improvement account includes (a) the P15,000 cost of improvements with a total estimated useful life of 12 years, which Summer, as tenant made to leased premises in January 2013; (b) movable assembly line equipment costing P8,500, which was installed in the leased premises in December 2014; and (c) real estate taxes of P2,500 paid by Summer, which under the terms of the lease, should have been paid by the landlord. Summer paid its rent in full during 2014. A 10 -year nonrenewable lease was signed January 3,2013, for the leased building that Summer used in manufacturing operations. Item 7: The balance in the Organization Expenses account includes pre-operating costs incurred during the organizational period. Questions: 1.
Patents will have have an audited audited balance balance as of December 31,2014 of a. P85,000 c. P66,000 b. P64,000 d. P46,000
2.
The adjusted balance of Licensing Agreement – Agreement – A A as of December 31, 2014 is a. P20,000 c. P10,000 b. P0 d. P50,000
3.
The adjusted balance of Licensing Agreement – Agreement – B B as of December 31, 2014 a. P66,000 c. P45,000 b. P85,000 d. P64,000
4.
Leasehold improvements, net of amortization, audited balance as of December 31,2014 is a. P26,000 c. P13,200 b. P15,000 d. P12,000
5.
The net adjustment to Retained earnings to reflect all the the necessary corrections from Item 1 to 7 will amount to a. P84,500 debit c. P83,000 debit b. P84,500 credit d. P55,400 debit
10,000 85,000 26,000 10,500 29,000 24,000 50,000 49,000
The following information relate to accounts that may yet require adjustment: Item 1: Patents for Summer’s Summer’s manufacturing process were purchased January 2, 2014, at a co st of P68,000. An additional P17,000 was spent in December 2014 to improve machinery covered by the patents and charged to the Patents account. The patents had a remaining legal term of 17 years. Item 2: On January 3, 2013, Summer purchased two licensing agreements; at that time they were believed to have unli mited useful lives. The balance in the Licensing Agreement – A account included its purchase price of P48,000 and P2,000 in acquisition expenses. Licensing Agreement – – B also was purchased on January 3, 2013, for P50,000 but it has been reduced by credit of P1,000 for the advance collection of revenue from the agreement.
PROBLEM NO. 5 Select the best answer for each of the foll owing: 1.
The most effective means for the auditor auditor to determine determine whether a recorded intangible asset possesses the characteristics of an asset is to a. Vouch the purchase by reference to underlying underlying documentation. b. Inquire as to the status of patent applications. c. Evaluate the future revenue-producing capacity of the intangible asset. d. Analyze research research and development development expenditures to determine that only those expenditures possessing future economic benefit have been capitalized.
2.
In auditing auditing intangible assets, an auditor auditor most most likely would review or recompute amortization and determine whether the amortization period is reasonable in support of management’s financial statement assertion of a. Valuation. b. Completeness. c. Existence or occurrence. d. Rights and obligations.
Item 3: In December 2013, an explosion caused a permanent 60 percent reduction in the expected revenue-producing value of Licensing Agreement Agreement – – A, A, and in January 2015 a flood caused additional damage, which rendered the agreement worthless. Item 4: A study of Licensing Agreement – – B made by Summer in January 2014 revealed that its estimated remaining life expectancy was only 10 years as of January 1, 2014. Item 5: The balance in the Goodwill account includes P24,000 paid December 30,2013, for an advertising program, which it is estimated will assist in increasing Summer’s sales over a period of four years following the disbursement.
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3. Assuming TLL Co. has capitalized all research research and development costs associated with patent. patent. You, CPA, CPA, who is examining this account, will probably a. Confer with management regarding transfer of the amount from the balance sheet to the income statement. b. Confirm that the patent is registered and on file with with the intellectual property office. c. Confer with with management management regarding regarding a change in the title of the account to "goodwill." d. Confer with with management management regarding ownership ownership of the patent. 4.
a. b. c. d. 5.
There is goodwill goodwill involved in the acquisition of a business if the purchase price paid is i n excess of the proprietorship of the business acquired.
False; True. True; False. False; False. True; True.
Which of the following comparisons would would be the most most appropriate audit test for the amount of recorded goodwill? a. The purchase price and the book value of assets assets purchased. b. The purchase price and the fair fair value of assets purchased. c. The figure figure for goodwill specified specified in the contract contract for purchase. d. Earnings in excess of 5% of net assets for the past five years.
Goodwill might be viewed as the enjoyment of a profit by a company in excess of the normal or usual return for the industry as a whole but such goodwill is not recorded if it has not been purchased or paid for.
- now do th e DIY DIY dril l -
DO-IT-YOURSELF DO-IT-YOURSELF (DIY) DRILL PROBLEM NO. 1
1.
On December 31, 2011, Probe Corporation Corporation acquired the following three intangible assets:
2.
•
•
•
A trademark for P300,000. The trademark has 7 years remaining legal life. It is anticipated anticipated that the trademark will be renewed in the future, indefinitely, without problem. Goodwill for P1,500,000. The goodwill is associated with Probe’s Nexus Manufacturing reporting unit. A customer list for P220,000. By contract, Probe has exclusive use of the the list for 5 years. Because of market conditions, it is expected that the list will have economic value for just 3 years.
On December 31, 2012, before any adjusting entries for the year were made, the following information was assembled about each of the intangible assets: d) Because of a decline in the economy, economy, the trademark is now expected to generate cash flows of just P10,000 per year. The useful life of trademark trademark still extends beyond the foreseeable horizon. e) The cash flows expected to be generated by the Nexus Manufacturing reporting unit is P250,000 per year for the next 22 years. Book values and fair values of the assets and liabilities of the Nexus Manufacturing reporting unit are as follows: Book values Fair values Identifiable assets P2,700,000 P3,000,000 Goodwill 1,500,000 ? Liabilities 1,800,000 1,800,000 f)
The cash flows expected to be generated by the customer list are P120,000 in 2013 and P80,000 in 2014.
REQUIRED: Based on the above and the result of your audit, determine the following: (Assume that the appropriate discount rate for all items is 6%):
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3.
4.
5.
Total amortization for the year 2012 a. P 73,333 c. P141,515 b. P116,190 d. P 86,857 Impairment loss for the year 2012 a. P 90,476 c. P179,584 b. P133,333 d. P 0 Carrying amount amount of Trademark as of December 31, 2012 a. P300,000 c. P166,667 b. P257,143 d. P120,416 Carrying amount amount of Goodwill as of December December 31, 2012 a. P1,500,000 c. P1,431,818 b. P1,425,000 d. P1,462,500 Carrying amount amount of Customer Customer list as of December 31, 2012 a. P220,000 c. P176,000 b. P146,667 d. P 0
PROBLEM NO. 2 On November 15, 2012, Rodeo Corporation acquired Rapids, a company that operates a scenic railway along the coast of a popular tourist area. The summarized statement statement of financial position at fair values of Rapids on July 1, 2012, reflecting the terms of acquisition was: Goodwill Operating license Property-train stations and land Rail track and coaches Steam engines (2) Purchase consideration
P 200,000 1,200,000 300,000 300,000 1,000,000 P3,000,000
The operating license is for ten years. years. It has recently been renewed by the transport authority and is stated at the cost of its renewal. The carrying amounts amounts of the property and rail track and coaches are based on their estimated replacement cost. The engines are valued valued at their net selling price. On December 1, 2012, the boiler of one of the steam engines exploded, completely destroying the whole engine. Fortunately no one was injured, but the engine was beyond
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repair. Due to its age, a replacement could not be obtained. Because of the reduced passenger capacity, the estimated value in use of the business after the accident was assessed at P2 million.
6.
7. Passenger numbers after the accident were below expectations even after allowing for the reduced capacity. A market research report concluded that tourists were not using the railway because of the fear o f a similar accident occurring to the remaining remaining engine. In the light of this, the value in use of the business was re-assessed on December 31, 2012 at P1.8 million. million. On this this date Rodeo received an offer of P900,000 in respect of the transferable operating license. QUESTIONS: Based on the above and the result of your audit, compute the carrying amount of the following as of December 31, 2012 after recognizing the impairment loss, if any:
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Goodwill a. P120,000 b. P166,667
c. P200,000 d. P 0
Operating license a. P900,000 b. P866,667
c. P771,429 d. P720,000
8. Property – Property – train train stations and land a. P200,000 b. P192,857 9.
Rail track and coaches a. P200,000 b. P216,667
10. Steam engines a. P562,500 b. P642,857
c. P216,667 d. P168,750
c. P168,750 d. P192,857
c. P500,000 d. P600,000
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AP.05
