Question

Hardnosed Equipment purchased a patent on October 1, 2006, for $150,000 plus $10,000 in legal fees. At the time, Hardnosed Equipment planned to use the patent for 10 years and then sell it for $40,000.

At the end of 2008, Hardnosed Equipment estimated that the undiscounted net cash flows from the patent would be $110,000 and the discounted cash flow, $95,000. The fair value of the patent on December 31, 2008 was $96,000.

Required:

1. Compute the 2006 and 2007 amortization for the patent using the straight-line method.

2. Determine if the patent is impaired on December 31, 2008 and, if impaired, the size of the loss. Explain the test for impairment.

3. How would your answer to Required 2 differ if the patent had not been amortized by Hardnosed Equipment.

Answer 1

1. Patent cost = Cost price + Legal fees

= $150000 + $10000

= $160000

Salvage value = $40000 and useful life = 10 years

Amortization as per straight lline method = (Cost - salvage value) / useful life

Amortization amount per year = ($160000 - $40000) / 10

= $12000

2016 Amortization (3 months) = $12000 * 3 /12

= $3000

2017 Amortization (12 months) = $12000

2. Carrying amount of patent on December 31, 2008 is: Cost - Accumulated amortization till 2008

Accumulated amortization on December 31,2008 = Amortization in 2016 + amortization in 2017 + amortization in 2018

= $3000 + $12000 + $12000

= $27000

So, carrying amount of patent on December 31, 2008 = $160000 - $27000

= $133000

Undiscounted cash flows = $110000

Here, patent will be impaired because the carrying amount ($133000) of the patent is more than the undiscounted future cash flows ($110000).

Impairment loss = Carrying amount - fair value

= $133000 - $96000

= $37000

Test of impairment of patent :

An intangible asset with a finite useful life is tested for impairment using a two step impairment test.

Step 1: The carrying amount of the asset is compared with the sum of the undiscounted cash flows expected to result from the use of the asset and its disposition.

Step 2: If the carrying amount exceeds the totalundiscounted future cash flows, then the asset is impaired and an impairment loss equal to the difference the carrying amount of the asset and its fair value is recorded.

3. If the patent had not been amortized by Hardnosed equipment, then,

Carrying amount of the patent on December 31, 2008 (without amortization) = Cost = $160000

Undiscounted cash flows = $110000

Carrying amount exceeds undiscounted cash flows, so patent will be impaired.

Impairment loss on December 31, 2008 = Carrying amount - fair value

= $160000 - $96000

= $64000