Question

Cyclops Company has its own research department. However, the company purchases patents from time to time. The following is a summary of transactions involving patents now owned by the company.

• During 2014 and 2015, Cyclops spent a total of P459,000 in developing a new process that was patented (Patent A) on April 1, 2016; additional legal and other costs of P50,000 were incurred.

• A patent (Patent B) developed by Nanette Inventor, an inventor, was purchased for P187,500 on December 1, 2017, on which date it had an estimated useful life of 12 ½ years.

• During 2016, 2017 and 2018, research and development activities cost P510,000. No additional patents resulted from these activities.

• A patent infringement suit brought by the company against a competitor because of the manufacture of articles infringing on Patent B was successfully prosecuted at a cost of P42,600. A decision in the case was rendered in June 2018.

• On July 1, 2019, Patent C was purchased for P172,800. This patent had 16 years yet to run.

• During 2020, Cyclops experienced P180,000 on patent development. However, the company is still undecided as to how the patent, if approved by the Bureau of Patents, will generate probable future economic benefits.

Assume that the legal life of each patent is also its useful life.

Required:

1. Prepare the journal entries for the above transactions and related amortization from 2014 to 2020.
2. Determine the following:

1. Patent A’s carrying amount on December 31, 2020
2. Patent B’s carrying amount on December 31, 2020
3. Patent C’s carrying amount on December 31, 2020

Total amortization expense for the year ended December 31, 2020

these are all the information given.

Answer 1

Intangible assets can be difficult to understand and incorporate into the decision-making process. In this section we explain them in more detail and provide examples of how to amortize each type of intangible asset.

Fundamentals of Intangible Assets

Intangibles are recorded at their acquisition cost, as are tangible assets. The costs of internally generated intangible assets, such as a patent developed through research and development, are recorded as expenses when incurred. An exception is legal costs to register or defend an intangible asset. For example, if a company incurs legal costs to defend a patent it has developed internally, the costs associated with developing the patent are recorded as an expense, but the legal costs associated with defending the patent would be capitalized as a patent intangible asset.

Amortization of intangible assets is handled differently than depreciation of tangible assets. Intangible assets are typically amortized using the straight-line method; there is typically no salvage value, as the usefulness of the asset is used up over its lifetime, and no accumulated amortization account is needed. Additionally, based on regulations, certain intangible assets are restricted and given limited life spans, while others are infinite in their economic life and not amortized.

Copyrights

While copyrights have a finite life span of 70 years beyond the author’s death, they are amortized over their estimated useful life. Therefore, if a company acquired a copyright on a new graphic novel for $10,000 and estimated it would be able to sell that graphic novel for the next ten years, it would amortize $1,000 a year ($10,000/ten years), and the journal entry would be as shown. Assume that the novel began sales on January 1, 2019.

Patents

Patents are issued to the inventor of the product by the federal government and last twenty years. All costs associated with creating the product being patented (such as research and development costs) are expensed; however, direct costs to obtain the patent could be capitalized. Otherwise, patents are capitalized only when purchased. Like copyrights, patents are amortized over their useful life, which can be shorter than twenty years due to changing technology. Assume Mech Tech purchased the patent for a new pump system. The patent cost $20,000, and the company expects the pump to be a useful product for the next twenty years. Mech Tech will then amortize the $20,000 over the next twenty years, which is $1,000 a year.

Trademarks

Companies can register their trademarks with the federal government for ten years with the opportunity to renew the trademark every ten years. Trademarks are recorded as assets only when they are purchased from another company and are valued based on market price at the time of purchase. In this case, these trademarks are amortized over the expected useful life. In some cases, the trademark may be seen as having an indefinite life, in which case there would be no amortization.

Goodwill

From an accounting standpoint, goodwill is internally generated and is not recorded as an asset unless it is purchased during the acquisition of another company. The purchase of goodwill occurs when one company buys another company for an amount greater than the total value of the company’s net assets. The value difference between net assets and the purchase price is then recorded as goodwill on the purchaser’s financial statements. For example, say the London Hoops professional basketball team was sold for $10 million. The new owner received net assets of $7 million, so the goodwill (value of the London Hoops above its net assets) is $3 million. The following journal entry shows how the new owner would record this purchase.

Goodwill does not have an expected life span and therefore is not amortized. However, a company is required to compare the book value of goodwill to its market value at least annually to determine if it needs to be adjusted. This comparison process is called testing for impairment. If the market value of goodwill is found to be lower than the book value, then goodwill needs to be reduced to its market value. If goodwill is impaired, it is reduced with a credit, and an impairment loss is debited. Goodwill is never increased beyond its original cost. For example, if the new owner of London Hoops assesses that London Hoops now has a fair value of $9,000,000 rather than the $10,000,000 of the original purchase, the owner would need to record the impairment as shown in the following journal entry.

Intangible Assets

Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, and are created through time and effort. Intangible assets are identified separately on a company’s financial statements, and come in two primary forms: legal intangibles and competitive intangibles.

Legal intangibles are also known as intellectual property, and include trade secrets, copyrights, patents, and trademarks. An example would be Coca-Cola’s drink formula which is a closely held trade secret that only a few employees know; this is an example of an internally developed intangible asset.

Competitive intangibles include collaboration, leverage, structural activities, and customer loyalty. Human capital is the primary source of competitive intangibles.

Goodwill

Goodwill is technically an intangible asset, but is usually listed separately on a company’s balance sheet. Goodwill is only recognized through an acquisition of a company or business combination and is calculated as the difference between the amount of money paid to acquire a company and the fair or book value of the acquired company’s net assets. Goodwill is a type of intangible asset that is acquired and recorded due to a business acquisition or combination rather unlike other intangible assets, which may be internally developed by the company.

Example

Company XX is a car dealership with assets consisting of 10 cars valued at $100,000, an office valued at $150,000, and long-term debt valued at $25,000. Company XX‘s net assets total $100,000+$150,000−$25,000=$225,000$100,000+$150,000−$25,000=$225,000. Company XX has a top-performing sales personnel who are loyal to the company and refuse to leave. Company YY is a larger car dealership in the area and decides to purchase Company XX for $300,000 in order to capitalize on Company XX‘s sales force. The extra $300,000−$225,000=$75,000$300,000−$225,000=$75,000 that Company YY paid above Company XX‘s net assets are recognized by Company YY as Goodwill on their balance sheet.

Useful Lives

Intangible assets have a useful life that is either identifiable or indefinite. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, which ever is shorter. Intangible assets with indefinite useful lives are assessed each year for impairment. Impairment losses are determined by subtracting the asset’s market value from the asset’s book/carrying value. If an impairment loss is found it is recognized on the income statement and the intangible asset value is reduced.

Under US GAAP, intangible assets are classified into: Purchased vs. Internally Created Intangibles, and Limited-Life vs. Indefinite-Life Intangibles.

Financial Statement Recognition

Firms initially record intangible assets at cost, however only costs associated with the outright purchase in the acquisition of an intangible asset. Research and development costs incurred during the internal development or self-creation of an intangible asset are not costs that can be capitalized. This then means that some companies have very valuable assets that they are not allowed to recognize on their balance sheets under US GAAP.