Administrative Quiz 4 due today Project 3 due Monday 3/2 Final Exam – Section 1 (10:15 – 12:05) Wednesday 3/18 at 10:15 Section 2 (5:30) Monday, 3/16 at.

• Administrative• Quiz 4 due today• Project 3 due Monday 3/2• Final Exam –

• Section 1 (10:15 – 12:05) Wednesday 3/18 at 10:15

• Section 2 (5:30) Monday, 3/16 at 5:30• Chapters 10, 11, 12

• Today• Wrap up ch. 11 • Ch. 12 Intangible Assets

AgendaAgenda

• Lack physical existence• Represent entity’s rights and

privileges• Not financial instruments• Long term in nature

Intangibles: Intangibles: CharacteristicsCharacteristics

• Intangibles are written off over their useful lives, where the assets have determinable (finite) useful lives.

• Where the intangibles have indefinite useful lives, they are not amortized

Amortization of Amortization of Intangible AssetsIntangible Assets

• Marketing-related (i.e., trademark, trade name)

• Customer-related (i.e., customer lists, customer relationships)

• Artistic-related (i.e., copyrights)• Contract-related (i.e., franchise, licenses

or permits).• Technology-related (i.e., product patent,

process patent)• Goodwill

Specific Intangibles: Specific Intangibles: TypesTypes

• Trademarks and trade names are renewable indefinitely by the original user in periods of 10 years each.

• Costs of acquired trademarks or trade names are capitalized.

• If trademarks or trade names are developed by a business, all direct costs (except R&D costs) are capitalized.

Marketing-Related Marketing-Related Intangibles: Trademarks Intangibles: Trademarks

and Trade Namesand Trade Names

• Include:

•customer lists

•order or production backlogs

•customer relationships

• Amortized over useful life

Customer-Related Customer-Related IntangiblesIntangibles

• Copyrights are granted for life of the creator plus 70 years.

• Copyrights can be sold or assigned, but cannot be renewed.

• Copyrights are amortized over their useful life.

• Costs of acquiring copyrights are capitalized.

• Research and development costs involved are expensed as incurred.

Artistic-Related Artistic-Related Intangibles: CopyrightsIntangibles: Copyrights

• A franchise is a contractual agreement under which the franchisor grants the franchisee:

• the right to sell certain products or services,

• the right to use certain trademarks or trade names, or

• the right to perform certain functions, within a certain geographical area.

• A franchise may be for a limited time, or for an indefinite time period.

• The cost of a franchise (for a limited time) is amortized over the franchise term.

• A franchise (for an unlimited time) is carried at cost and not amortized.

• Annual payments for a franchise are expensed.

Contract-Related Contract-Related IntangiblesIntangibles

• A patent gives an exclusive right to the holder for 20 years.

• Costs of purchasing patents are capitalized.• Costs to research and develop patents are

expensed as incurred.• Patents are amortized over the shorter of

the legal life (20 years) or their useful lives.• Legal fees incurred to successfully defend

patents are capitalized.

Technology-Related Technology-Related Intangibles: PatentsIntangibles: Patents

• Goodwill can be sold only with the business – it is recognized only when an entire business is purchased. Internally created goodwill is not capitalized

• Goodwill is the excess of:

• the purchase price over the fair value of the tangible and intangible net assets acquired

• Goodwill has an indefinite life and should not be amortized but is subject to impairment

• Impairment test should be performed at least annually

• If applicable, an impairment loss is recorded

GoodwillGoodwill

Finite-life intangible assets:

• US GAAP reports at cost less accumulated amortization

• If an active market exists, IFRS allows reporting at fair value, less accumulated amortization and impairment

Internally generated intangibles:

• US GAAP: R&D costs are generally expense as incurred

• IFRS: Costs are identified as belonging to the Research OR development phase

• Costs in the research phase are always expensed

• Costs in development phase are expensed unless the following met:

• Technical feasibility of completing the intangible asset

• Intention to complete the intangible asset

• Ability to use or sell it

• Generation of future economic benefits (existence of a market or internal usefulness of the asset)

• Adequate resources to complete the development

• Ability to reliably measure the expenses during development

US GAAP vs. IFRSUS GAAP vs. IFRS

Type of Asset• Property, Plant

& Equipment

• Limited Life Intangible

• Indefinite-life intangible, other than goodwill

Impairment Tests• Recoverability test,

then fair value test

• Recoverability test, then fair value test

• Fair value test

Impairment TestsImpairment Tests

Is there Impairment to Intangible Assets?Is there Impairment to Intangible Assets? For Intangible Assets with Finite Useful Lives:

1. Recoverability Test: Is the sum of future cash flow (NO DISCOUNTING) less than asset’s carrying amount?

Yes No - Impairment has Occurred - No Impairment

2. Determine loss: does an active market exit for the asset?

Yes No Loss = Carrying amount – FV of asset Loss = Carrying amount – PV of expected FCF (DISCOUNTED)

For Intangible Assets, other than Goodwill, with Indefinite Useful Lives: 1. No Recoverability test is performed 2. Compares fair value of intangible asset with assets' carrying amount:

Loss = Carrying amount – FV of asset

For Goodwill 1. Compares fair value of reporting unit to it’s carrying amount, including goodwill 2. If FV of reporting unit < carrying amount:

a. Determine fair value (implied value) of GW and compare to the GW carrying amount Implied value = FV of reporting unit – FV of net identifiable assets, excluding GW

On January 1, 2001, Nemo, Inc. acquired a patent. The patent has an estimated useful life of 20 years. Presented below is information related to the patent at December 31, 2005:

Acquisition cost: $500,000Carrying amount: $375,000Expected future cash flows: $350,000Fair Value: $325,000

What is impairment loss, if any, at 12/31/05?

Would answer change if expected future cash flows were $380,000?

Intangible Impairment Intangible Impairment Example – Finite LifeExample – Finite Life

On January 1, 2001, Nemo, Inc. acquired a trademark with an indefinite useful life. Presented below is information related to the trademark at December 31, 2005:

Acquisition cost: $400,000Carrying amount: $322,000Expected future cash flows: $340,000Fair Value: $315,000

What is impairment loss, if any, at 12/31/05?

Intangible Impairment Intangible Impairment Example – Indefinite LifeExample – Indefinite Life

On January 1, 2006, CSI Industries purchased all the outstanding shares of Grissom, Inc. for $200,000 At the time of purchase, Grissom, Inc. had the following assets and liabilities recorded on its balance sheet:

Goodwill ExampleGoodwill Example

Assets Liabilities Cash 10,000 Accounts Payable 30,000 Accounts Receivable 60,000 Notes Payable 100,000 I nventory 70,000 Property, Plant and Equipment

130,000

Goodwill ExampleGoodwill ExampleOn J anuary 1, 2006, CSI I ndustries purchased all the outstanding shares of Grissom, I nc. f or $200,000 At the time of purchase, Grissom, I nc. had the f ollowing assets and liabilities recorded on its balance sheet:

Assets Liabilities Cash 10,000 Accounts Payable 30,000 Accounts Receivable 60,000 Notes Payable 100,000 I nventory 70,000 Property, Plant and Equipment

130,000

270,000 What are the net assets of the company? Why would CSI pay $200,000 to acquire Grissom?

Goodwill ExampleGoodwill Example

Assume that Grissom developed a unique process for identifying DNA from blood samples and that the company owns a patent on this process. An independent appraisal determines the value of the patent to be $20,000. In addition, the appraisal determines that the fair value of the company’s inventory is $80,000, the fair value of its PPE is $150,000 and, because of a drop in interest rates, the market value of its notes payable is $120,000. Calculate the amount, if any, of goodwill that should be recorded.

1/1/06 BV 1/1/06 FVcash 10,000 10,000 AR 60,000 60,000 Inventory 70,000 80,000 PP&E 130,000 150,000 Patent 20,000 AP (30,000) (30,000) NP (100,000) (120,000) Net assets 140,000 170,000 Cash paid 200,000 Goodwill 30,000

• Step 1: Compares fair value of reporting units to its carrying amount, including goodwill

• If FV of reporting unit > carrying amount, no impairment

• If FV of reporting unit < carrying amount, go to Step 2

• Step 2

• Determine fair value (implied value) of goodwill and compare to the goodwill carrying amount

• Implied value is equal to:

Fair value of reporting unit - Net identifiable assets, excluding GW

Goodwill Impairment Test: Goodwill Impairment Test: 2-Step Process2-Step Process

Goodwill Impairment Goodwill Impairment ExampleExample

Recall the previous example. Suppose that the Grissom operating unit has perf ormed poorly over the past two years. On 12/ 31/ 07, the unit’s assets and liabilities are as f ollows:

Assets: Liabilities: Cash 7,000 Accounts Payable 40,000 Accounts Receivable 30,000 Notes Payable 110,000 I nventory 60,000 Patent 18,000 Goodwill 30,000 Property, Plant and Equipment

135,000

Assume that CSI received an off er to purchase the Grissom unit f or $120,000. Does the company need to record an impairment charge for goodwill?

Goodwill Impairment Goodwill Impairment ExampleExample

12/31/07 BV

Cash 7,000 AR 30,000 Inventory 60,000 PP&E 135,000 Patent 18,000 Goodwill 30,000 AP (40,000) NP (110,000) Net assets 130,000 Fair value 120,000 Fair value < Net asset (10,000)

No Impairment example:

Hornbuckle Corporation has 4 divisions: The Anderson Division has the following net assets:

Cash 11,000 AR 120,000 PP&E 95,000 Goodwill 150,000 l: AP & NP (125,000)Net assets 251,000

FV of Anderson Division 325,000

• Step 1: Compares fair value of reporting unit to its carrying amount, including goodwill• If FV of reporting unit > carrying amount, no impairment

So – don’t need to go to Step 2 – no impairment

Goodwill Impairment Test: Goodwill Impairment Test: 2-Step Process Example2-Step Process Example

Impairment Example (Carrying amt = FV of net identifiable assets, excl. GW):

Hornbuckle Corp. has 4 divisions. The B Division has the following net assets:

Cash 11,000 AR 120,000 PP&E 95,000 Goodwill 150,000 l: AP & NP (125,000)Net assets 251,000

FV of B Division 200,000 • Step 1: Compare FV of reporting unit to its carrying amount, including

GW• Here, FV of reporting unit < carrying amount, so go to Step 2

• Step 2: Determine fair value (implied value) of goodwill and compare to the goodwill carrying amount. Here, assume that the carrying amount equals the FV of net identifiable assets (excluding goodwill)

• Implied value is: Fair value of reporting unit – Fair value of net identifiable assets, excluding goodwill:

200,000 – [251,000-150,000] = 99,000

• Loss on impairment = GW carrying amount – GW implied value:

150,000 – 99,000 = 51,000

Goodwill Impairment Test: Goodwill Impairment Test: 2-Step Process Example2-Step Process Example

Impairment Example (Carrying amt ≠ FV of net identifiable assets, excl. GW):

Hornbuckle Corp. has 4 divisions. The B Division has the following net assets:

Cash 11,000 AR 120,000 PP&E 95,000 Goodwill 150,000 l: AP & NP (125,000)Net assets 251,000

FV of B Division 200,000 • Step 1: Compare FV of reporting unit to its carrying amount, including

GW• Here, FV of reporting unit < carrying amount, so go to Step 2

• Step 2: Determine fair value (implied value) of goodwill and compare to the goodwill carrying amount. Here, assume that the fair value of PP&E is 110,000

• Implied value is: Fair value of reporting unit – Fair value of net identifiable assets, excluding goodwill:

200,000 – [266,000-150,000] = 84,000

• Loss on impairment = GW carrying amount – GW implied value:

150,000 – 84,000 = 66,000

Goodwill Impairment Test: Goodwill Impairment Test: 2-Step Process Example2-Step Process Example

Reversals of impairment losses:• US GAAP prohibits• IFRS allows under special circumstances, except for goodwill

Impairment assessment• US GAAP:

• uses a 2-step process for finite life intangibles• performs the impairment calculation at the reporting unit level (an operating

segment, for which management reviews financial information)• IFRS:

• uses a 1-step process for all intangibles• performs the impairment calculation at the cash-generating unit level (“the

smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets”)

US GAAP vs. IFRSUS GAAP vs. IFRS

• Contra accounts are not normally shown.• On the balance sheet, all intangible assets

should be reported as a separate item.• On income statement, amortization expense

and impairment losses should be presented as part of income from continuing operations.

• Unless goodwill impairment loss is associated with discontinued operations, it should also be reported as part of continuing operations.

Presentation of Presentation of IntangiblesIntangibles

• R & D costs involve searching for new products and processes

• R & D costs are expensed unless the costs have alternative future uses

• Disclosure is required in the financial statements of the total R & D costs charged to expense each period for which an income statement is presented.

Research and Research and Development CostsDevelopment Costs