Question

(TCO C) What are intangible assets?

How are limited-life intangibles accounted for subsequent to acquisition?

On January 1, 2018, Molden Co. signed an agreement to operate as a franchisee of Mold Removal Co. for an initial franchise fee of $100,000. The agreement provides that the fee is not refundable and no future services are required of the franchisor. The agreement also provides that 5% of the Revenue from the franchise must be paid to the franchisor annually. Molden's revenue from the franchise for 2018 was $1,800,000. Molden estimates the useful life of the franchise to be 10 years.

Instructions:

1. Show a schedule of what should be shown in the Intangible Assets Section of Molden's Balance Sheet at December 31, 2018. Show supporting computations in good form.

2. Show a schedule showing all the expenses resulting from these transactions that would appear on Molden's Income Statement for the year ended December 31, 2018. Show supporting computations please.

Answer 1

1. Intangible assets are the assets those assets that can not be physically touched but they have value to the business. Such assets have value to the business but they are not like the tangible assets that can be touched.
Tangible assets are in the form of rights, patents, trademarks or franchise. All these rights add value to the business but they can not be touched. Intangible assets are also depleted over the years of their life but unlike tangible assets, they are amortized and not depreciated.
2. Tangible assets can have a definite life or sometimes the definite life cannot be ascertained. For those tangible assets that life can be ascertained or those who have a definite life, Cost of such intangible assets is depleted over the years of their useful life.
For examples if we have purchase franchise rights that will allow us to operate for 2 years and we have paid $10,000 then the actual cost of 10k will be written off in two years.

3. Since the franchise has a useful life of 10years we will amortize the initial cost of 100K that is paid to acquire the rights of franchise.
Now to calculate the amount that will be amortized every year we will divide the cost by the useful life.

Franchise cost/Useful life.
This gives us the below $100000/10=10000.

Amortization expenses DR 10000
To Franchise CR 10000

4. Now to stay in business Molden will have to pay 5% of the revenue to the franchisor. This percentage is called the royalty that is paid every year after the rights to operate are purchased.
This cost is not to be considered for amortization and should not be added to the value of the asset as this cost will be variable depending upon the sales of that year and this expense should be shown separately as the royalty paid in P&L
So we will pass the below JE
Royalty expenses AC DR 9,000
To Franchisor 9,000

(18,00,000*5%)