Chapter 13: Study Notes

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Chapter 13: Study Notes

13.1 – Characteristics of Intangible Assets

Intangible assets have the following characteristics:

  • Non-Physical Form: An intangible asset does not have a physical form.
  • Monetary Assets are Excluded: All monetary assets are not considered intangible assets.
  • Future Economic Benefit: An intangible asset is an asset and therefore must meet the definition of being an asset.

13.2 – Common Intangible Assets

Intangible Asset Asset Life Subject to Amortization? Subject to Impairment Test?
Patents Limited Yes Yes
Copyrights Limited Yes Yes
Computer Software Limited Yes Yes
Goodwill Unlimited No Yes
Franchises Limited Yes Yes
Trade Mark/Trade Name Unlimited No Yes
Customer Lists Unlimited No Yes
Research and Development N/A N/A – expense N/A – expense

13.3 – Fundamental Theory of Intangible Assets

There are two types of intangible assets: limited-life and unlimited life.

Limited-life intangible: Has a limited life and is subject to impairment testing and amortization.

Unlimited life: Has an unlimited life and is only subject to impairment testing.

To assign a value to the intangible assets we will use the following criteria:

1) Purchased intangible assets are assigned their cost price and this is recorded as an asset.

2) Internally created intangible assets will have their indirect costs expensed when incurred. Only direct costs will be recorded.

13.4 – Valuation and Recognition of Intangible Assets

1. Purchased intangible assets: If an intangible asset is purchased then the cost to purchase the intangible will be debited to an asset account.

2. Internally Created Intangibles: Internally created intangible assets will have their indirect costs expensed when incurred. Only direct costs will be recorded.

13.5 – Amortization of Intangible Assets

Intangible assets may be subject to obsolescence or lose their value over time due to a variety of factors.  To compensate for this decay of value we will use amortization. Amortization is simply the process of converting an asset into an expense based on a systematic set of guidelines.

If an intangible asset has an indefinite life (i.e. a trade mark) then it should not be subject to amortization.

To record amortization you debit the amortization expense and credit the intangible asset account.

If the intangible asset has a residual value it must be subtracted from the amortization base before calculating the amortization expense.

If the intangible asset’s useful life is evaluated to be longer or shorter then the amortization expense rate must be recalculated.

13.6 – Impairment Testing of Intangible Assets

Impairment is when an asset is reported at a higher value than the expected value it will bring to the business over the course of its lifetime. When an asset is impaired it must be written down to its correct valuation using fair value methods.

It is a two-step process: first step is recoverability test using undiscounted cash flows (only applies to limited-life intangibles). The second step is to use a fair value method to value the intangible asset (use discounted cash flows).

If the recoverability test using undiscounted cash flows is less than the book value of the intangible asset then the intangible asset is impaired and must be written down to fair value.

13.7 – Research and Development

Research: Conducting experiments or other investigations to discover new knowledge.

Development: Converting knowledge obtained from research into a viable product or improving an existing product.

All R&D expense is expensed in the period incurred. After a product has been developed, we capitalize to an asset account.

13.8 – Financial Statement Presentation

Amortization expense is to be reported on the income statement under other revenue and expenses.

Intangible assets are to be reported on the balance sheet at net book value. No contra-asset accounts are reported on the balance sheet for intangible assets.

Summary

Intangible Asset If Purchased If Internally Created Subject to Amortization? Subject to Impairment Test?
Limited-Life Capitalized All R&D Expensed Yes – Over useful life Yes – Recoverability + Fair Value Test
Unlimited Life Capitalized All R&D Expensed No Yes – Fair Value Test

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