CHAPTER
14 14-1.
SUBSTANTIVE TESTS OF INTANGIBLE ASSETS
The decision whether a given expenditure on intangible asset to be treated as expense or asset requires judgment. Expenditure giving rise to future benefits will be classified as assets while those expenditure the future benefits from which are uncertain are charged of as expense in the year incurred. The expected benefit from the intangible assets can be assessed in terms of the following: a) Patents: Actual production of the goods covered by the patent b) Goodwill: Review of actual excess income as well as actual income of the investee c) Trademark / Tradename: Continuous production of the product covered by the trademark/tradename.
14-2.
Research and Development Costs vary widely among companies. Many expenditures do have future worth, while others are so highly uncertain as to future value that recording them as assets is clearly improper. The auditor’s interest in auditing Research and Development costs stems from the objective of determining whether they should be deferred or charged against current operations. He shall be guided by GAAP in judging whether the client’s treatment of the Research and Development Costs is justified or not.
14-3.
Menfro, Inc. The rapid amortization of the leasehold for the first twelve (12) years resulted to an understatement of income totaling to P60,000: Correct amortization P450,000 x 12 20 Amortization per client (P27,500 x 12)
P270,000
Over-amortization
P 60,000
330,000
In view of the above, the amount of P60,000 should be added back to Retained Earnings as correction of prior years’ profits. Furthermore, amortization of P22,500 for the 13th year should be recorded. These adjustments would result to a net increase in the Retained Earnings balance which will enable the company to declare dividends without depleting the Retained Earnings balance significantly.
14-2
Applied Auditing 2014 Edition Solutions Manual
14-4.
Requirement (a) The annual depreciation for years 11 to 25 is P1,667. By the end of the 25th year, the building would be fully depreciated. [(50,000 – 25,000) / 15 years) Requirement (b) If the original lease had contained a renewal clause for an additional 20 years, the depreciation rate would still be 5%, which is based on the original term of the lease. The renewal of the lease contract is not certain and therefore will not be considered in the determination of the amortization period.
14-5.
Process Development Company Process Development Company Patents Amortization Schedule Description Patent
P Q R
Cost as Recorded P 40,000 120,000 160,000 P320,000
Less: Adjustment as per BIR requirement 80,000 As Adjusted P240,000
2015 P1,212.12 3,529.41 4,705.88 P9,447.41 (2,361.85) P7,085.56 (a)
Amortization Per Client 2006 to 2014 Total Adjustment P 19,393.94 P 20,606.06 P(5,151.52) 56,470.59 60,000.00 (15,000) 75,294.12 80,000.00 (20,000) P151,158.65 P160,606.06
As Adjusted P 15,454.54 45,000.00 60,000.00
(37,789.67) P113,368.98 (b)
P120,454.54
* Based on 17 years legal life. (a) 2006 Amortization: P =
30,000 16.5
x 0.5 = P 909.09
Q&R =
210,000 17
x 0.5 =
6,176.47 P7,085.56
(b) 2007 to 2014 Amortization: P =
30,000 16.5
Q&R =
210,000 17
x 8
=P 14,545.45
x 0.5 = 98,823.53 P113,368.98
(40,151.52) P120,454.54
Substantive Tests of Intangible Assets
14-3
Adjusting Journal Entries (1)
(2)
14-6.
Capital in excess of par value Patent P Patent Q Patent R To adjust patent valuation to conform to BIR requirement.
80,000.00
Accumulated amortization – Patent P Accumulated amortization – Patent Q Accumulated amortization – Patent R Retained earnings – Correction of prior years’ profit To adjust amortization provision from 2006 to 2014.
5,151.52 15,000.00 20,000.00
10,000.00 30,000.00 40,000.00
40,151.52
Cartwright Corporation Note to Instructor: For ease of discussion, the adjusting entries in the solution are dated to correspond with the original erroneous journal entries. In actual practice, they would be dated as of the year-end. Jan. 1
10
5
Apr. 1
May 15
Organization Expenses Intangibles To classify incorporation fees.
17,500
Organization Expenses Intangibles To classify legal fees for the organization of the company.
7,500
Advertising Expense Intangibles To expense advertising costs.
15,000
Land Building Intangibles To reclassify land and buildings for R & D activities.
15,000 20,000
Research and Development Expenses Intangibles To expense materials purchased.
15,000*
* Alternatively, unused materials and supplies, if material, may be set up as prepaid expenses.
17,500
7,500
15,000
35,000
15,000
14-4
Applied Auditing 2014 Edition Solutions Manual June 30
July 1
Dec. 10
31
31
31
Patent Intangibles To reclassify the patent.
10,000
Income Summary / Retained Earnings Intangibles To record operating loss.
12,000
Research and Development Expenses Intangibles To record acquisition of equipment.
12,000
Research and Development Expenses Intangibles To expense R & D costs.
30,000
10,000
12,000
12,000
30,000
Research and Development Expenses Accumulated Depreciation: Building To record ¾ year depreciation on R & D building (20-year life) from April 1 entry.
750
Amortization Expense Patent To record ½ year amortization (20year life) on June 30 patent.
250
750
250
PAS 38 prohibits capitalization of start-up expenses such as organization costs. No amortization should therefore be recorded. 14-7.
Harper, Inc. Calculation of Goodwill Average year-end net assets: (P2,400,000 5) Average annual earnings (P400,000 5) Less: Normal return on average year-end assets (10% x P480,000) Excess annual earnings Excess annual earnings capitalized at 20% or Goodwill P32,000 12%
P 480,000
P 80,000 48,000 P 32,000
= P160,000
Substantive Tests of Intangible Assets 14-8.
14-5
Bayer, Inc.
Net tangible assets per records, Nov. 1, 2015 Add: Agreed increase in value of equipment Net adjusted tangible assets Add: Value of Goodwill (Schedules 1 & 2) Total amount to be paid for net tangible assets and goodwill
Bayer, Inc. P328,500 40,000 P368,500 74,900
Lead, Inc. P298,500
P443,400
P311,400
P298,500 12,900
Supporting Computations: Schedule 1: Goodwill of Bayer, Inc. Average pre-tax earnings 11.1.10 to 11.1.15 Less: Additional annual depreciation equipment taken over at P40,000 in excess of book value (P40,000 / 5) Adjusted pre-tax earnings Less: Required earnings on net tangible assets (15% x P368,500)
P82,000
Excess annual pre-tax earnings
P18,725
Goodwill (excess earnings capitalized at 25%)
P74,900
8,000 P74,000 55,275
Schedule 2: Goodwill of Lead, Inc.
14-9.
Average pre-tax earnings 11.1.10 to 11.1.15 Less: Adjustment for effect of organization cost written off in 2014 (P20,000 / 5) Adjusted pre-tax earnings Less: Required earnings on net tangible assets (15% x P298,500)
P44,000
Excess annual pre-tax earnings
P 3,225
Goodwill (excess earnings capitalized at 25%)
P12,900
4,000 P48,000 44,775
Phoenix Supply Company Requirement (a) Allocation of the P137,500 cost to the individual assets in the group of assets acquired is based on the relative fair value of the individual assets.
14-6
Applied Auditing 2014 Edition Solutions Manual Asset Patent A Patent B Equipment Land
Appraisal Value
Portion of Total Value
P 30,000 40,000 19,700 62,000
30/151.7 40/151.7 19.7/151.7 62/151.7
Total Cost x x x x
P137,500 137,500 137,500 137,500
P151,700
Allocated Cost = = = =
P 27,192 36,256 17,856 56,196 P137,500
Journal entries for 2013, 2014 and 2015, relative to intangible assets, are as follows: 2013 Apr. 27 Patent A Patent B Equipment Land Cash To record the acquisition of assets.
27,192 36,256 17,856 56,196
Oct. 31 Amortization of Patents Patent A (27,192 / 5 x 6/12) Patent B (36,256 / 12 x 6/12) To record amortization of patents for 2004.
4,230
137,500
2,719 1,511
2014 Mar. 7 Legal Expenses 17,600 Cash To record legal fees related to defense of patents. Mar. 7 Amortization of Patents Patent A To record amortization on Patent A to date of write-off (Nov. 2013 to Feb. 2014).
17,600
1,813
Mar. 7 Loss on Patent A 22,660 Patent A To record write-off of Patent A after unsuccessful defense.
1,813
22,660
Substantive Tests of Intangible Assets Oct. 31 Amortization of Patents 3,021 Patent B To record amortization of Patent B for 2014.
14-7
3,021
2015 Oct. 31 Amortization of Patents 3,021 Patent B To record amortization on Patent B for 2015.
3,021
Computations Amortization for 2015: Patent A: (P27,192 / 5 years) (6 / 12) Patent B: (P36,256 / 12 years) (6 / 12) Amortization on Patent A, 10/31/2013 – 3/7/2014: (P27,192 / 5 years) (4/12) Book value of Patent A to 3/7/2014: Cost Amortization recognized P2,719 1,813
Amortization for 2014 and 2015: Patent B: (P36,256/12 years)
P 2,719 1,511 P 4,230
P 1,813 P27,192 4,532 P22,660
P 3,021
The cost basis of patent B is P36,256 - P1,511 + P8,800 - P3,546). 2014, a full year’s amortization is taken by dividing the unamortized cost by the remaining useful life. In 2015 this is P39,999/10 ½ years or P3,809. Requirement (b) The legal costs of a court defense should be charged to expense whether the suit is won or lost because it does not meet the recognition criteria. Also, the unsuccessful defense implies that Patent A is of no further value to the company and leads to the write-off of the remaining unamortized cost of that patent.
14-8
Applied Auditing 2014 Edition Solutions Manual
14-10.
Balagtas Enterprises Requirement (a) Patents 1. Balance before adjustment, 12/31/15 P550,000 Correction: Deduct unamortized balance of P75,000 expenditures incorrectly debited to account on 1/1/03: P75,000 x (7 years/10 years) (52,500) [AJE (1)] Corrected balance before 2015 amortization P497,500 2.
2015 Amortization Patent having two years remaining life Unamortized cost: P210,000 x (7 years/14 years) = P105,000 Amortization: P105,000/2 Remaining Patents Unamortized cost: P497,500 - P105,000 = P392,500 Amortization: P392,500/7
Franchise Agreement 1. Balance before adjustment, 12/31/15 Correction: Deduct periodic payment charged to account Corrected balance before 2015 amortization 2.
2015 Amortization: P50,000 / 5 years
Organization Costs 1. Balance before adjustment, 12/31/15 Correction: Legal fees incorrectly charged to Goodwill account in 2007 Amortization of above costs, 1998 - 2004 (P45,000 / 40) (7 years)
2.
P 52,500
56,071 P108,571 [AJE (2)]
P 95,000 (45,000) [AJE (3)] P 50,000 P 10,000 [AJE (4)]
P102,000 P45,000
[AJE (5)]
7,875
37,125 [AJE (6)] P139,125 [AJE (7)]
No amortization need be taken up in 2015. With the effectivity of PAS 38 which does not allow deferment or capitalization of organization costs, the entire balance of this account, should have been charged off against income in 2013. Adjusting entry in 2015 will be: Retained earnings – Prior period adjustment Organization costs
139,125 139,125
Substantive Tests of Intangible Assets Goodwill 1. Balance before adjustment, 12/31/15 Correction: Reclassification of legal fees to Organization Costs Reclassification of advertising fee to Advertising Expense Amortization on Goodwill for 2013 (P200,000 / 40 years) Balance 12.31.13 2.
14-9
P345,000 ( 45,000) (100,000) ( 5,000) P195,000
Effective January 2005, Revised PAS 36 prohibits amortization of intangibles with indefinite life - Goodwill being one of them. Hence, no amortization would be taken up starting 2005. Assessment for possible impairment should be done annually or whenever there is an indication that the asset may be impaired.
Adjusting Journal Entries: Patents AJE (1) Retained Earnings Patents
52,500
AJE (2) Cost of Goods Sold Patents
108,571
52,500
108,571
Franchise Agreement AJE (3) Selling and Administrative Franchise Expense Franchise Agreement
45,000
AJE (4) Selling and Administrative Expense Franchise Agreement
10,000
45,000
10,000
Organization Cost AJE (5) Organization Costs Goodwill
45,000 45,000
AJE (6) Retained Earnings Organization Costs
7,875
AJE (7) Retained Earnings Organization Costs
139,125
7,875
139,125
14-10
Applied Auditing 2014 Edition Solutions Manual Goodwill AJE (8) Selling and Administrative – Advertising Expense Goodwill
100,000 100,000
AJE (9) Retained Earnings Goodwill
5,000 5,000
Requirement (b) (1) Retained Earnings Selling and Administrative – Franchise Expense Selling and Administrative – Advertising Expense Organization Costs Franchise Agreement Goodwill Patents
204,500 45,000 100,000 102,000 45,000 150,000 52,500
Summary: Retained Earnings AJE (1) (7) (9) (6)
(Dr.) Cr. (52,500) (139,125) 5,000 7,875 (204,500)
Organization Costs AJE (5) (6) (7)
Dr. (Cr.) 45,000 (7,875) (139,125) (102,000)
Goodwill AJE
Dr. (Cr.) 45,000 100,000 5,000 150,000
(5) (8) (9)
(2) Cost of Goods Sold Selling and Administrative Expense Patents Franchise Agreement
108,571 10,000 108,571 10,000
Substantive Tests of Intangible Assets 14-11.
14-11
Balagtas Company Requirement (a) The deficiencies listed below are apparent from the balance sheet and the explanations given. The assumption is made that costs incurred have been properly classified by Mr. Balagtas. The correct treatment of each item is presented in the column on the right. Deficiency
Correct Treatment
1.
Capitalization of expenses: Research and development Marketing research Personnel recruitment and training Legal fees relative to organization of the corporation Operating expenses
Treat all the items as expenses in 2015 income statement.
2.
No depreciation was taken on machinery.
Expense appropriate amounts in the 2015 income statement.
3.
Ordinary shares account does not reflect the par value of the outstanding shares (11,000).
Increase ordinary shares by par value of 1,000 shares.
4.
No statement of shareholders’ equity and explanation of shares issued is presented.
The statement should be provided, including dates and numbers of shares issued, peso amounts assigned, and the bases for assigning peso values in noncash transactions. Also, land given by Mario should be recorded at fair value; services by Pedro should be recognized as an expense at fair value. Additional paid-in capital may be recognized as the result of the above.
5.
No accumulated deficit presented.
“Deficit accumulated during development stage” should be included in the shareholders’ equity section. The amount results from corrections made in items 1 and 2 above.
14-12
Applied Auditing 2014 Edition Solutions Manual Requirement (b) Additional items which should be included are:
14-12.
1.
Income statement, including amounts of revenue and expenses recognized since the inception of the enterprise in 2015.
2.
Statement of cash flows, including cumulative amounts of sources and uses of cash since the inception of the enterprise.
3.
Additional disclosures: identification of the company as a development-stage enterprise, and description of significant development-stage activities.
Nikko Corporation Requirement (a) In a purchase transaction, assets are recorded at their acquisition price, which becomes the cost basis to the acquiring corporation. The book values of the assets for Rain Company are irrelevant. Requirement (b) When a price is paid for a group of assets, the total price must be allocated to the individual assets. Because we know neither the total fair value of the tangible and other intangible assets acquired from Rain Company nor the price to be paid by the Nikko Corporation, we cannot determine whether Nikko Corporation has any goodwill to record. The total price to be paid by the Nikko Corporation is indefinite but it may be estimated by discounting the expected receipts (1% of net sales) at the end of each of the next 5 years and adding the initial P450,000 cash payment. If the estimated purchase price exceeds the sum of the estimated fair values of the tangible and other assets purchased, then the excess may be recorded as goodwill.
14-13.
Golden Springs Shopping Center, Inc. Interest on mortgage bonds: An amount equal to the interest cost incurred in 2013 (P60,000) is clearly a cost that can be associated with the normal construction period and can be regarded as a normal element of the capitalized cost of the physical assets of the shopping center because the construction period would have ended at the end of the year if the typhoon had not occurred. The decision to use debt capital to finance the shopping center was made with full knowledge that interest would accrue during the construction period and add to the total cost of building the center and bringing it to the point at which it would produce revenue. The future income to be generated by the shopping center must have been estimated to be more than sufficient to recover all of the expected costs of
Substantive Tests of Intangible Assets
14-13
building the center and preparing it for occupancy, including interest during the construction period. Instead of treating interest during construction as an element of the cost of the physical assets, it can be argued that it represents an element of the general cost of bringing the business to the point of revenue production and should therefore be treated as an organization cost. This view regards interest during construction as just another of the many expenditures that are necessary to acquire and organize the physical assets of a new business but do not attach to any specific assets. Treated as an organization cost, interest during construction would be expensed as a start-up cost. Another alternative to capitalizing an amount equal to the 2013 interest cost is to treat it as interest expense. This treatment is inappropriate because it assumes that the decision to use debt capital to finance construction is a decision deliberately to incur an expense for the interest that accrues during the expected construction period. The extension of the construction period to October 2014 because of the typhoon was externally imposed and so the interest capitalization period continues until final construction is complete. That is, the additional interest cost is capitalized and not expensed as a loss from the typhoon. Cost of obtaining tenants: Both the 2013 and 2014 costs of obtaining tenants should be capitalized and amortized over the life of the leases. The fact that all of the tenants who were signed when the typhoon occurred accepted the October occupancy date indicates that the total cost of obtaining tenants was not affected by the delay. The cost of obtaining tenants has a direct and easily identifiable relationship to the rental income to be earned over the terms of the leases. Under these circumstances, the problem of reliably measuring periodic net income is best solved by matching costs with the revenues to which they are directly related. Promotional advertising: The 2013 cost of promotional advertising should be written off as a start-up cost. The 2014 cost of promotional advertising should also be expensed. The initial expense treatment of the 2013 advertising cost is appropriate because it is a start-up cost. The 2014 advertising cost may also be considered as a start-up cost or simply expensed as advertising cost incurred.
14-14 14-14.
Applied Auditing 2014 Edition Solutions Manual Lee Manufacturing Corporation
General Ledger Accounts Cash Accounts receivable Allowance for doubtful accounts Inventories Machinery Equipment Accumulated depreciation Patents Leasehold improvements Prepaid expenses Organization costs Goodwill Licensing agreement no. 1 Licensing agreement no. 2 Accounts payable Unearned revenue Capital stock Retained earnings, Jan. 1, 2015 Sales Cost of goods sold
Trial Balance Debit Credit P 61,000 92,500 P 500 38,500 75,000 29,000 10,000 85,000 26,000 10,500 29,000 24,000 50,000 49,000
Income Statement Debit Credit P
(8)
P 2,500
(1) (8)
17,000 8,500 (1) P 17,000 (8) 11,000 (9) (7) (4) (5)
(3)
29,000 24,000 1,250 29,250
Balance Sheet Debit Credit 61,000 95,000 (500) 38,500 92,000 37,500 (10,000) 68,000 15,000 10,500 19,500
1,000
147,500 12,500 300,000
50,000 P (3)
1,000
27,000 768,500 454,000
Selling and general expenses Start-up expenses
173,000
Interest expense Extraordinary losses Accumulated amortization: patents Accumulated amortization: leasehold improvements Accumulated amortization: licensing agreements Prior period adjustment – licensing agreement no. 1 Prior period adjustment – amortization of leasehold improvements Net income for 2015 Totals
3,500 12,000
*
Lee Manufacturing Corporation Financial Statement Worksheet For the Year Ended December 31, 2015 Adjustments Debit Credit
P1,239,000
P (2) (6) (10) (7) (7) (9)
3,400 5,500 1,500 8,000 16,000 29,000
P
147,500 13,500 300,000 (27,000)
768,500
464,400 181,000 45,000 3,500 12,000
P1,239,000
(4) (5)
1,250 29,250
(10)
1,500 P124,400
(2)
3,400
(3,400)
(10)
3,000
(3,000)
(6)
5,500
(5,500) (30,500) *
P124,400
P
62,600 768,500
P
768,500
P
470,600
P
(1,500) * 62,600 470,600
Generally, adjustments in the current period that could have been determined by management in a prior period should enter into the determination of net income in the current period. However, because the 2015 financial statements were not prepared in conformity with generally accepted accounting principles, these retroactive adjustments are considered to be errors and treated as prior period adjustments and, therefore, should be applied against beginning retained earnings.
Substantive Tests of Intangible Assets 14-14.
14-15
Lee Manufacturing Corporation (continued . . . ) Adjusting entries (shown on worksheet): (1)
(2)
(3)
(4)
Machinery Patents To transfer cost of improving machinery to the fixed asset account.
17,000 17,000
Cost of Goods Sold Accumulated Amortization: Patents To record 2015 patent amortization (1/20 x P68,000).
3,400
Licensing Agreement No. 2 Unearned Revenue To classify revenue received in advance on licensing agreement as unearned revenue.
1,000
Prior Period Adjustment – Licensing Agreement No. 1 Licensing Agreement No. 1 To take up 2014 amortization (40 year life). (Note 1)
3,400
1,000
1,250 1,250
Note 1: Under the revised PAS 38 made effective January 1, 2005, intangible assets with indefinite useful lives need not be amortized but periodically assessed for possible impairment. This problem may also be solved by disregarding the 40-year amortization period for Licensing Agreement #1. The flood that rendered Licensing Agreement #1 worthless in January 2016 should be fully disclosed in the December 31, 2015 statements. (5)
Prior Period Adjustment – Licensing Agreement No. 1 Licensing Agreement No. 1 To write off the permanent 60% reduction in the expected revenueproducing value of licensing agreement no. 1 caused by the December 2014 explosion (60% x P48,750).
29,250 29,250
14-16
Applied Auditing 2014 Edition Solutions Manual (6)
(7)
(8)
(9)
Cost of Goods Sold Accumulated Amortization: Licensing Agreements To record 2015 amortization of licensing agreement no. 1 [(P50,000 – P1,250 – P29,250) 39] and no. 2 (P50,000 10).
5,500 5,500
Selling and General Expenses Start-up Expenses Goodwill To transfer items improperly charged to Goodwill.
8,000 16,000
Start-up Expenses Organization Costs To expense other organization costs.
29,000
Equipment Accounts Receivable – Lessor Leasehold Improvements To charge the Equipment account with movable equipment and to record a receivable from the landlord for the real estate taxes erroneously paid by Lee.
(10) Cost of Goods Sold Prior Period Adjustment – Amortization of Leasehold Improvements Accumulated Amortization: Leasehold Improvements To record 2014 and 2015 amortization of leasehold improvements based on 10-year life of lease (2 x 10% x P15,000).
24,000
29,000
8,500 2,500 11,000
1,500 1,500 3,000
Substantive Tests of Intangible Assets 14-15.
14-17
Broadway Corporation Requirement (1) Broadway Corporation Intangibles Section of Balance Sheet December 31, 2015 Franchise from IE Copy Service, Inc., net of accumulated amortization of P6,870 (Schedule 1) Patent, net of accumulated amortization of P2,050 (Schedule 2) Trademark, net of accumulated amortization of P7,294 (Schedule 3) Total intangibles
P 61,830 14,350 42,706 P118,886
Schedule 1: Computation of Franchise from IE Copy Service, Inc. Cost of franchise at January 1, 2015 Down payment Present value of installments Initial amount capitalized Amortization of franchise for 2015 (P68,700 10 years) Franchise balance, December 31, 2015
P25,000 43,700 P68,700 (6,870) P61,830
Schedule 2: Computation of Patent Capitalized cost of patent at January 2, 2015 – legal fees and other costs associated with registration Amortization of patent for 2015 (P16,400 8 years) Patent balance, December 31, 2015
P16,400 (2,050) P14,350
14-18
Applied Auditing 2014 Edition Solutions Manual Schedule 3: Computation of Trademark
Cost of trademark at July 1, 2012 Amortization through December 31, 2015 (P40,000 20 years = P2,000 x 3 ½ years) Balance, December 31, 2015 Deduct accumulated amortization Trademark balance, December 31, 2015
Cost P40,000
P40,000 (7,000) P33,000
Accumulated Amortization
P7,000 P7,000
Cost of successful litigation in defense of trademark should be charged to expense. Requirement (2) Broadway Corporation Expenses Resulting from Intangibles Transactions For the Year Ended December 31, 2015 Franchise from IE Copy Service, Inc. Amortization of franchise (Schedule 1) Franchise fee on revenues from operations (P900,000 x 5%) Imputed interest expense on unpaid balance of initial franchise fee (P43,700 x 14%) Amortization of patent (Schedule 2) Litigation expense – Trademark Amortization of trademark Total expenses 14-16.
P 6,870 45,000 6,118 P57,988 2,050 10,000 2,000 P72,038
Precious Opal Corporation (a) 2015 amortization: P16,000 10 = P1,600. 12/31/06 book value: P16,000 – P1,600 = P14,400. 2016 amortization: (P16,000 10) = P1,600. 12/31/07 book value: (P16,000 – P3,200) = P12,800. (b) 2016 amortization: (P12,800) 4 = P3,200. 12/31/16 book value: P12,800 – P3,200 = P9,600. Legal fees in successfully defending the trade name should be charged to expense.
Substantive Tests of Intangible Assets
14-19
(c) Carrying amount (P19,733) > Fair Value (P15,000); thus the tradename fails the recoverability test. The new carrying value is P15,000. The fair value is considered the recoverable amount. The estimated total future flows from the trade name of P16,000 need to be discounted and the resulting present value would in most probability be a lower amount than P15,000. 2017 amortization (after recording impairment loss): P15,000 ÷ 8 = P1,875. 12/31/17 book value: P15,000 – P1,875 = P13,125 14-17.
Miguel Alfonso Corporation Requirement (a) Attorney’s fees in connection with organization of the corporation Costs of meetings of incorporators to discuss organizational activities State filing fees to incorporate Total organization costs
P15,000 7,000 1,000 P23,000
Drafting and design equipment, P10,000, should be classified as part of fixed assets, rather than as organization costs. Requirement (b) Organization Expense ................................................................ 23,000 Cash (Payables)................................................................ 23,000 14-18.
Jo Tan Company Requirement (a) Jo Tan Company INTANGIBLES SECTION OF BALANCE SHEET December 31, 2016
Patent from Francis Argante Company, net of accumulated amortization of P560,000 (Schedule 1) Franchise from JC Company, net of accumulated amortization of P48,000 (Schedule 2) Total intangibles
P1,440,000 432,000 P1,872,000
14-20
Applied Auditing 2014 Edition Solutions Manual
Schedule 1 Computation of Patent from Francis Argante Company Cost of patent at date of purchase Amortization of patent for 2015 (P2,000,000 10 years) Amortization of patent for 2016 (P1,800,000 5 years) Patent balance
P2,000,000 (200,000) 1,800,000 (360,000) P1,440,000
Schedule 2 Computation of Franchise from JC Company Cost of franchise at date of purchase Amortization of franchise for 2013 (P480,000 10) Franchise balance
P 480,000 (48,000) P 432,000
Requirement (b) Jo Tan Company Income Statement Effect For the year ended December 31, 2016 Patent from Francis Argante Company: Amortization of patent for 2016 (P1,800,000 5 years) Franchise from JC Company: Amortization of franchise for 2016 (P480,000 10) Payment to Reagan Company (P2,500,000 X 5%) Research and development costs Total charged against income 14-19.
P360,000
P 48,000 125,000
173,000 433,000 P966,000
Twinkle Industries Requirement (a) Patent X Life in years Life in months (12 X 17) Amortization per month Number of months amortized to date Year 2013 2014 2015 2016
Month 10 12 12 12 46
Book value 12/31/16 P23,700: (P30,600 – [46 X P150])
17 204 P150
Substantive Tests of Intangible Assets Patent Y Life in years Life in months (12 X 10) Amortization per month Number of months amortized to date Year 2014 2015 2016
14-21 10 120 P125
Month 6 12 12 30
Book value 12/31/16 P11,250: (P15,000 – [P125 X 30]) Patent Z Life in years Life in months (12 X 4) Amortization per month Number of months amortized to date Year 2015 2016
4 48 P300
Month 4 12 16
Book value 12/31/16 P9,600: (P14,400 – [P300 X 16]) At December 31, 2016 Patent X Patent Y Patent Z Total
P23,700 11,250 9,600 P44,550
Requirement (b) Analysis of 2017 transactions 1.
The P245,700 incurred for research and development should be expensed.
2.
The book value of Patent Y is P11,250 and its estimated future cash flows are P6,000: (3 X P2,000) therefore Patent Y is impaired. The impairment loss is imputed as follows: Book value Less: Present value of future cash flows 2,000 X 2.57710 Loss recognized
P11,250 5,154 P 6,096
14-22
Applied Auditing 2014 Edition Solutions Manual Patent Y carrying amount (12/31/17) P5,154 At December 31, 2017 Patent X Patent Y Patent Z Patent AA Total
P21,900 5,164 6,000 34,560 P67,624
(P23,700 – [12 X P150]) (Present value of future cash flows) (P9,600 – [12 X P300]) (P36,480 – P1,920*)
Patent AA amortization Life in years Life in months Amortization per month P320 X 6 = P1,920
9 1/2 114 P320
Patent Y: Value in Use 2,000 2,000 2,000
x x x
0.9259 = 0.8573 = 0.7983 =
P1,852 1,715 1,597 P5,164
or 2,000 14-20.
x
2.582 =
P5,164
Depp Corporation Requirement (a) Cash ................................................................................................ 50,000 Receivables ................................................................................................ 90,000 Inventory ................................................................................................ 125,000 Land ................................................................................................ 60,000 Buildings ................................................................................................ 75,000 Equipment ................................................................................................ 70,000 Trademarks ................................................................................................ 15,000 Goodwill ................................................................................................ 65,000 Accounts Payable ................................................................ 200,000 Notes Payable ................................................................ 100,000 Cash ................................................................................................ 250,000 Note that the building and equipment would be recorded at the 7/1/15 cost to Brigham; accumulated depreciation accounts would not be recorded.
14-23
Substantive Tests of Intangible Assets Requirement (b) 1. Amortization Expense (Trademarks) ................................ 1,500 Trademarks ([P15,000 – P3,000] 1/4 X 6/12)................................
1,500
2. Goodwill will not be amortized. 14-21.
Bill Santos Company Requirement (a) December 31, 2015 Loss on Impairment ................................................................ 1,100,000* Copyrights ................................................................ *Carrying amount Fair value Loss on impairment
1,100,000
P4,300,000 3,200,000 P1,100,000
Requirement (b) Copyright Amortization Expense ................................ 320,000* Copyrights ................................................................ *New carrying amount Useful life Amortization per year
CV 12.31.15 Amortization, 2016 CV 12.31.16
Historical Cost P4,300,000 430,000 P3,870,000
320,000
P3,200,000 10 years P 320,000 Fair Value 12.31.07
Fair Value P3,200,000 320,000 P2,880,000 Recovery
P3,400,000 520,000
Requirement (c) Copyrights ................................................................................................ 520,000 Copyright Amortization Expense or Gain on Recovery of Previously Recognized Impairment ................................
520,000
14-24 14-22.
Applied Auditing 2014 Edition Solutions Manual Español Co. Franchises................................................................................................ 42,000 Prepaid Rent ................................................................................................ 28,000 Retained Earnings (Organization Costs of P6,000 in 2015) ................................................................................................ 6,000 Retained Earnings (P16,000 – P6,000) ................................ 10,000 Patents ................................................................................................ 74,000 Legal fees ................................................................................................ 12,650 Research and Development Expense ................................................................ (P75,000 + P160,000) ................................................................ 235,000 Goodwill................................................................................................ 278,400 Intangible Assets ................................................................ 686,050 5,250 Franchise Amortization Expense (P42,000 8)................................ Retained Earnings (P42,000 8 X 6/12)................................ 2,625 Franchises ................................................................
7,875
14,000 Rent Expense (P28,000 2)................................................................ Retained Earnings (P28,000 2 X 3/12)................................ 3,500 Prepaid Rent ................................................................
17,500
Patent Amortization Expense ................................................................ 7,400 Patents ................................................................................................ 7,400 (P74,000 10) Note—No amortization of goodwill; goodwill should be tested for impairment on at least an annual basis in future periods. 14-23.
Sim Laboratories Requirement (a) Costs to obtain patent Jan. 2008 1996 amortization (P62,050 17) Carrying value, 12/31/08
P62,050 (3,650) P58,400
All costs incurred prior to January 2008 are related to research and development activities and were expensed as incurred.
Substantive Tests of Intangible Assets
14-25
Requirement (b) 1/1/09 carrying value of patent 2009 amortization (P62,050 17) 2010 amortization Legal fees to defend patent 12/10 Carrying value, 12/31/10 2011 amortization (P86,800 14) 2012 amortization Carrying value, 12/31/12
P58,400 P3,650 3,650
6,200 6,200
(7,300) 51,100 35,700 86,800 (12,400) P74,400
The costs incurred in 2009 and 2011 are related to research and development activities and are expensed as incurred. Legal fees in successful defense of the patent in 2001 could be capitalized and considered GAAP. Requirement (c) 1/1/13 carrying value 2013 amortization (P74,400 5) 2014 amortization 2015 amortization Carrying value, 12/31/15
P74,400 P14,880 14,880 14,880
(44,640) P29,760
The legal costs in 2015 were expensed because the suit was unsuccessful. Even if the lawsuit was successful, the legal fees would be likewise charged to expense. This is in accordance with PAS 38, Intangibles which was made effective in 2004.
