Manuel L.

Quezon University
Manila

Integrated Review - Auditing BLD

1st Semester 2020-2021

Audit of Intangible Assets

Summary of Accounting Principles for Intangible Assets

Definitions:
Intangible asset An identifiable nonmonetary asset without physical substance.
The systematic allocation of the depreciable amount of an intangible asset over its
Amortization
useful life.
The amount of cash or cash equivalents paid or the fair value of other consideration
given to acquire an asset at the time of its acquisition or construction, or, when
Cost
applicable, the amount attributed to that asset when initially recognized in
accordance with the specific requirements of other PFRSs.
The amount for which that asset could be exchanged between knowledgeable,
Fair value
willing parties in an arm’s length transaction.
Monetary assets Money held and assets to be received in fixed or determinable amounts of money.
Original and planned investigation undertaken with the prospect of gaining new
Research
scientific or technical knowledge and understanding.
The application of research findings or other knowledge to a plan or design for the
Development production of new or substantially improved materials, devices, products, processes,
systems or services before the start of commercial production or use.

Two important aspects of the definition of an Intangible Asset are:

I. Identifiability – Identifiable means

(a) Is separable, it is capable of being separated or divided from the entity and sold, transferred,
licensed, rented or exchanged, either individually or together with a related contract, asset or
liability OR
(b) Arises from contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or from other rights and obligations.

II. Inherent characteristics of assets are:

(a) Control - An entity controls an asset if the entity has the power to obtain the future economic
benefits flowing from the underlying resource and to restrict the access of others to those
benefits.
(b) Future Economic Benefits - The future economic benefits flowing from an intangible asset may
include revenue from the sale of products or services, cost savings, or other benefits resulting
from the use of the asset by the entity.
(c) Cost – An asset shall only be recognized if its cost or value can be measured reliably.

KEY OBSERVATIONS

Ø Identifiability is the major reason why internally generated goodwill is not recognized as an asset. Aside
from lacking control and unmeasurable cost of goodwill.
Ø Control is the reason why internally generated brands and the skills of employees arising from training
or experience is not an asset. However, cost also plays a major role in its non recognition.

Recognition and Initial Measurement

Ø An enterprise to recognize an intangible asset, whether purchased or self-created AT COST if, and only
if:
• It is probable that the future economic benefits that are attributable to the asset will flow to the
enterprise; and
• The cost of the asset can be measured reliably.

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Initial Measurement and Subsequent Expenditures

Ø Intangible assets are initially measured at cost.

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

Internally Generated Intangible Assets

I. It is sometimes difficult to assess whether an internally generated intangible asset qualifies for
recognition because of problems in

(a) Identifying whether and when there is an identifiable asset that will generate expected future
economic benefits;
(b) Determining the cost of the asset reliably. In some cases, the cost of generating an intangible
asset internally cannot be distinguished from the cost of maintaining or enhancing the entity’s
internally generated goodwill or of running day-to-day operations.

II. To assess whether an internally generated intangible asset meets the criteria for recognition, an entity
classifies the generation of the asset into:

(a) A research phase (b) A development phase

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

Research Phase
I. No intangible asset arising from research (or from the research phase of an internal project) shall be
recognized. Expenditure on research (or on the research phase of an internal project) shall be recognized
as an expense when it is incurred.

II. In the research phase of an internal project, an entity cannot demonstrate that an intangible asset exists
that will generate probable future economic benefits. Therefore, this expenditure is recognized as an
expense when it is incurred.

III. Examples of research activities are:

(a) Activities aimed at obtaining new knowledge

(b) The search for, evaluation and final selection of, applications of research findings or other
knowledge
(c) The search for alternatives for materials, devices, products, processes, systems or services
(d) The formulation, design, evaluation and final selection of possible alternatives for new or improved
materials, devices, products, processes, systems or services.

Development Phase
I. An intangible asset arising from development (or from the development phase of an internal project)
shall be recognized if, and only if, an entity can demonstrate all of the following:

(a) The technical feasibility of completing the intangible asset so that it will be available for use or sale.
(b) Its intention to complete the intangible asset and use or sell it.
(c) Its ability to use or sell the intangible asset.
(d) How the intangible asset will generate probable future economic benefits. Among other things, the
entity can demonstrate the existence of a market for the output of the intangible asset or the
intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
(e) The availability of adequate technical, financial and other resources to complete the development
and to use or sell the intangible asset.
(f) Its ability to measure reliably the expenditure attributable to the intangible asset during its
development.

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II. In the development phase of an internal project, an entity can, in some instances, identify an intangible
asset and demonstrate that the asset will generate probable future economic benefits. This is because
the development phase of a project is further advanced than the research phase.

III. Examples of development activities are:

(a) The design, construction and testing of pre-production or pre-use prototypes and models;
(b) The design of tools, jigs, moulds and dies involving new technology;
(c) The design, construction and operation of a pilot plant that is not of a scale economically feasible for
commercial production; and
(d) The design, construction and testing of a chosen alternative for new or improved materials, devices,
products, processes, systems or services.

IV. Internally generated brands, mastheads, publishing titles, customer lists and items similar in
substance shall not be recognized as intangible assets.

V. Expenditure on internally generated brands, mastheads, publishing titles, customer lists and items
similar in substance cannot be distinguished from the cost of developing the business as a whole.
Therefore, such items are not recognized as intangible assets.

Measurement Subsequent to Acquisition

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

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

Classification of Intangible Assets Based on Useful Life

Intangible assets are classified as:

• Indefinite life: No foreseeable limit to the period over which the asset is expected to
generate net cash inflows for the entity.
• Finite life: A limited period of benefit to the entity.

Measurement Subsequent to Acquisition of Intangible Assets with Finite Lives

The cost less residual value of an intangible asset with a finite useful life should be amortized over that life:

• The amortization method should reflect the pattern of benefits.

• If the pattern cannot be determined reliably, amortize by the straight-line method.
• The amortization charge is recognized in profit or loss unless another PFRS requires that it be
included in the cost of another asset.
• The amortization period should be reviewed at least annually.
• The asset should also be assessed for impairment in accordance with PAS 36.

Measurement Subsequent to Acquisition of Intangible Assets with Indefinite Lives

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

• Its useful life should be reviewed each reporting period to determine whether events and
circumstances continue to support an indefinite useful life assessment for that asset. If they
do not, the change in the useful life assessment from indefinite to finite should be accounted
for as a change in an accounting estimate.
• The asset should also be assessed for impairment in accordance with PAS 36.

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Audit of Intangible Assets
Key Principles on Certain Intangible Assets

Patents
• An exclusive right granted by the government to an inventor to control the manufacture, use or
sale of an invention
• Cost – Licensing and registration fees only for APPLIED AND REGISTERED patents and purchase
price and any directly attributable expenditure necessary in preparing the asset for its intended use
for PURCHASED PATENTS.
• Principles on amortization:
§ Amortization is based on the useful life or legal life (20 years), which ever is shorter.
§ If a competing patent is acquired to protect an original patent. The cost of the new
patent and the carrying amount of the original patent is amortized over the remaining
life of the original patent.
§ If a related patent is acquired to extend the life of an existing patent. The cost of the
new patent and the carrying amount of the original patent is amortized over the
extended period, unless if the remaining life of the new patent is shorter than the
extended period.

Goodwill
• An unidentifiable intangible asset that allows an enterprise to earn above normal income
• It is only purchased goodwill that is recognized as an asset which is the cost in excess of the fair value of
the net assets acquired in a business combination. This the premium paid in acquiring another business
or ordinary shares when control is achieved. Countless of times goodwill is referred to as BADWILL
because seemingly the purchaser had gotten fleeced in the sale of the net assets of the seller.
• Internally generated goodwill shall not be recognized as an asset.
• Methods of estimating goodwill

Ø Capitalization of “average excess earnings”

Ø Capitalization of “average earnings”
Ø Purchase or multiples of “average excess earnings”
Ø Present value of “average excess earnings”

EXAMPLE : Lets assume that a buyer is planning to buy the business of a competitor. The cumulative net
earnings for the past 5 years was P18,000,000. The current value of net assets of the seller was 10,000,000 only.
Meaning if the buyer is able to acquire the assets and assume the liabilities at fair value, the purchase price
would only be 10,000,000. But let us say that buyer will account for the past performance of the seller and
determine it as a contributor to additional income in the future from the purchase of the seller’s business.
Goodwill is determined by the following assuming a 20 percent rate of return and a 25% capitalization rate?

Average earnings (18M / 5) 3,600,000

Less: Normal earnings (10M x 20%) 2,000,000
Excess earnings or earnings from goodwill 1,600,000
Capitalized at 25% or divided by 25%
Goodwill 6,400,000

Ø The purchase price will then be 16,400,000 which is the price at fair value
plus the goodwill added to the fair value.
Ø A multiplier of let’s say 3 years if the “multiples of excess earnings” is
used or a PV factor of 3.17 if the discount rate is 10% and 4 periods shall
be used to compute for goodwill if for example the “PV of excess
earnings” will be used.

Average earnings (18M / 5) 3,600,000

Capitalized at 25% or divided by 25%
Purchase price 14,400,000

Trademark
• An exclusive right granted by the government that permits the use of distinctive symbols, labels, and
designs associated with the product or the organization.

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Audit of Intangible Assets
• Licensing and registration fees only for developed trademarks Cost of research, survey, design and
development cost is expensed.
• The legal life of a trademark is 10 years however it may be renewed for an additional 10 year period
for an unlimited number of times. Therefore the legal life of a trademark is indefinite and is not
subject to amortization but instead tested for impairment.

Computer Software
• IF the software is an integral part of the hardware for example the operating system of the PC, the
cost of the software shall be included in hardware cost
• Internally developed (whether for use or sale) charge to expense until technological feasibility is
achieved
• Cost to develop the software shall be capitalized once technological feasibility is reached either from
the creation of a “working model or a detailed program design”. Probable future benefits, intent and
ability to use or sell the software, resources to complete the software, and ability to measure cost
are also requirements for capitalization.
• Development activities have concluded and commercial production shall commence once the final
or “beta” version of the software has been produced. In accounting specially in US GAAP, the final
version is known as the “product master”
• The amortization method for computer software should reflect the pattern in which the asset’s
future economic benefits are expected to be consumed by the entity. If such pattern cannot be
determined reliably, the straight-line method is used.

PRACTICAL QUESTIONS

Problem 1
The following costs are generally incurred by a newly established entity:
Pre-opening cost of a business facility P250,000
Purchased recipes and secret formulas 150,000
Training, customer loyalty, and market share 140,000
Licensing, royalty, and standstill agreement 300,000
Operating and broadcast rights 112,000
Goodwill purchased in a business combination 500,000
A license to manufacture a steroid by means of a government grant 150,000
Cost of courses taken by management in quality engineering management 450,000
A television advertisement that will stimulate the sales in industry 100,000
Investment in associate 500,000
6 month lease payment in advance 300,000
Cost of equipment acquired through a finance lease 100,500
Internally developed customer list 120,500
Cost incurred in the corporation's formation and organization 230,000
Operating losses incurred in the start-up of the business 130,000
Initial franchise fees paid 175,000
Continuing franchise fees 50,000
Internally generated goodwill 800,000
Cost of testing in search for a product alternative 125,000
Cost of purchasing a patent from an inventor 137,000
Legal cost in securing a patent 70,000
Legal costs incurred in successfully defending a patent 55,500
Cost of developing brands, mastheads, and publishing title 200,000
Cost of purchasing a trademark 250,000
An operating system of a computer 125,000
Amount paid to a lessor for the exclusive right to rent a facility under an
operating lease agreement for a period of 10 years 100,000
Cost of improvements on a leased facility 250,000

How much from the above items, including goodwill, shall be recognized as intangible assets?

Problem 2
Candy was organized in 2019. Its accounting records include only one account for Candy Corporation all
intangible assets. The following is a summary of the entries that have been recorded and posted during the
years 2019 and 2020:

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Audit of Intangible Assets
Intangibles
7/1/19 Franchise expiring on June 30, 2027 P252,000
10/1 Advance payment on lease expiring on October 1, 2021 168,000
12/31 Net loss for 2019 including incorporation fee, P6,000, and
related legal fees of organizing the business, P30,000 (all
incurred in 2019) 96,000
1/2/20 Acquired patent with a useful life of 10 years 444,000
3/1 Cost of developing secret formula 450,000
4/1 Goodwill purchase 1,670,400
7/1 Legal fees for successful defense of patent purch on ‘1/2 75,900
10/1 Research and development costs on a new project 960,000

Required: Ignoring income tax effects, determine the following

1. The unamortized patent cost at December 31, 2020
2. The unamortized franchise cost at December 31, 2020
3. The amount of prepayments to be reported as of December 31, 2020
4. The adjusting entries on December 31, 2020, should include a net debit to the retained earnings account at:
5. As a result of the adjustments at December 31, 2020, the total charges against income of 2020 should be

Problem 3
The accounting records of Boracay Corp. which was organized in 2019 include only one account for all intangible
assets. The following is a summary of the items debited to the said account in 2019 and 2020:
Date Particulars Amount
July 1, 2019 Franchise (indefinite term) P1,260,000
Oct. 1 Lease advance payments (2-year term, starting 840,000
October 1, 2019)
Dec.31 Net loss for 2019 including incorporation fees
P30,000, and related legal fees of organizing the
business, P150,000 480,000
Jan 2, 2020 Purchased patent (10 year life) 2,220,000
Mar. 1 Cost of developing a recipe 2,250,000
Apr. 1 Purchased goodwill 8,352,000
Jul. 1 Legal fee for successful defense of the patent
purchased in Jan 2020 379,500

Audit notes:
a. On December 31, 2019, the management estimates that the annual net future cash flows from the franchise's
continued use was at P180,000. On December 31, 2020, this estimate was revised due to decline in product
demand to P150,000 annually.

b. On December 31, 2020, the estimated annual net future cash flows from the patent's continued use was at
P337,822 for its remaining life.

c. The prevailing market rate of interest as of December 31, 2019 and 2020 was consistent at 12%.

Based on the above information and on your audit, answer the following requirements:
1. What is the correct carrying value of the Franchise as of December 31, 2020?
2. What is the correct carrying value of the Patent as of December 31, 2020?
3. What is the total retroactive adjustment to retained earnings beginning in 2020 as a result of your audit?
4. What is the total amount chargeable to expense for the current year (2020) as a result of your audit?

Problem 4
Adobo Corp. holds a valuable patent on a precipitator that prevents certain types of air pollution. Adobo does
not manufacture or sell the products and process it develops. Instead, it conducts research and develops
products and processes which it patents, and then assigns patents to manufactures on a royalty basis.
Occasionally it sells patents. The following presents the summary of the activities in relation to the
aforementioned patent

2010-2011 Research aimed at the discovery of the new technology P3,840,000

Jan. 5, 2012 Design and construction of a prototype 876,000
March 15 Testing the prototype models 420,000
Jan. 2, 2013 Legal and other professional fees to process the patent
application (useful life is 15 years) 660,000

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Audit of Intangible Assets
Dec. 10, 2015 Legal fees paid to successfully defending the device patent 357,000
Jan 3, 2017 Acquisition of a competitive patent aimed at protecting
old patent and increasing expected revenue from the
original patent. 220,000
Jan 5, 2018 Acquisition of the related patent which extended the life
of the patents for additional 3 years 335,000
Dec. 31, 2020 Legal fees paid in unsuccessful patents infringement suit
against a competitor 250,000

1. What is the correct cost of the patent upon initial recognition?

2. What is the carrying value of the patent on December 31, 2013?
3. What is the amortization expense on the patent in 2017?
4. What is the carrying value of the patent on December 31, 2017?
5. What is the amortization expense on the patent in 2018?
6. What is the carrying value of the patent of December 31, 2019?
7. What is the total impairment loss from patent to be recognized in 2020?

Problem 5
Transactions during 2020 of the newly organized Key Chain Corporation included the following:

Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to complete
organization of the corporation.
15 Hired a clown to stand in front of the corporate office for 2 weeks and hound out
pamphlets and candy to create goodwill for the new enterprise. Clown cost, P10,000;
pamphlets and candy, P5,000.
Apr. 1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P 429,000

Patent application and licensing fees 63,500
Total P 492,500

It is estimated that in 6 years other companies will have developed improved

processes, making the Key Chain Corporation process obsolete.
May 1 Acquired both a license to use a special type of container and a distinctive trademark
to be printed on the container in exchange for 6,000 shares of Key Chain’s no-par
common stock selling for P50 per share. The license is worth twice as much as the
trademark, both of which may be used for 6 years.
July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be
developed in future research projects.
Dec. 31 Incurred salaries for an engineer and chemist involved in product development
totaling P1,750,000 in 2020.

Based on the above and the result of your audit, determine the following:

1. Cost of patent
2. Cost of licenses
3. Cost of trademark
4. Carrying amount of Intangible Assets
5. Total amount resulting from the foregoing transactions that should be expensed when incurred

Problem 6
On December 31, 2019, Silver Corporation acquired the following three intangible assets:

• A trademark for P300,000. The trademark has 7 years remaining legal life. It is anticipated that the
trademark will be renewed in the future, indefinitely, without problem.

• Goodwill for P1,500,000. The goodwill is associated with Silver’s Hayo Manufacturing reporting unit.

• A customer list for P220,000. By contract, Silver has exclusive use of the list for 5 years. Because of
market conditions, it is expected that the list will have economic value for just 3 years.

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Audit of Intangible Assets
On December 31, 2020, before any adjusting entries for the year were made, the following information was
assembled about each of the intangible assets:

• Because of a decline in the economy, the trademark is now expected to generate cash flows of just
P10,000 per year. The useful life of trademark still extends beyond the foreseeable horizon.

• The cash flows expected to be generated by the Hayo 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 Hayo 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

• The cash flows expected to be generated by the customer list are P120,000 in 2021 and P80,000 in
2022.

Based on the above and the result of your audit, determine the following: (Assume that the appropriate discount
rate for all items is 6%):
1. Total amortization for the year 2020
2. Impairment loss for the year 2020
3. Carrying value of Trademark as of December 31, 2020
4. Carrying value of Goodwill as of December 31, 2020
5. Carrying value of Customer list as of December 31, 2020

“Let them sleep while you grind. Let them spend while you save. Let them party while you work. Let them see
the result in 5 years”
-Anonymous

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