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A. Different Methods of Acquiring Intangible Assets

The following transactions pertain to the intangible assets of DAVAO, Inc. at December
31, 2019:

• On January 1, 2018, DAVAO signed an agreement to operate as a franchisee of

Choke-To-Go for 10 years with an initial franchise fee of P800,000. Of this amount,
a non-refundable down payment P200,000 was made when the agreement was
signed and the balance is payable in three annual installments of P200,000
beginning January 1, 2019. No future services are required in the franchise. The
implicit rate for a loan of this type is 12%. The agreement also provides that
DAVAO shall pay the franchisor an annual franchise fee of 3% of its annual
revenues. DAVAO’s 2019 revenue from its operations is P8,500,000.

• DAVAO incurred P650,000 of research and development costs to develop an

patent. On January 1, 2019, the patent was eventually granted and registered with
the Intellectual Property Office. Legal fees associated with the registration
amounted to P127,500. To control the benefits from its invention and to avoid
serious competition, DAVAO also purchased a competing patent amounting to
P75,000. DAVAO does not expect to use the competing patent. The useful life of
the registered patent is 12 years.

• A trademark was purchased from another party for P350,000 on September 1, 2019.
Expenditures for the successful defense of the trademark was P120,000. DAVAO
expects that the trademark’s useful life will be indefinite. There were no indications
of impairment on December 31, 2019.

1. How much is the carrying value of the intangible assets (franchise, patent and
trademark, respectively) on December 31, 2019? (Round off any present values to
FOUR decimal places)

Answer: P 1,011,163

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PROBLEM A

FRANCHISE
Cash flow PV factor PV of cash flows
Downpayment 200,000 1.0000 200,000
Present value of future payments 200,000 2.4018 480,360 PV of ordinary annuity at 12% for 3 periods
Cost of franchise, 1/1/2018 680,360
Less: accumulated amortization 136,072 Based on a useful life of 10 years.
Carrying value, 12/31/2019 544,288

At January 1, 2018:

Franchise 680,360
Discount on notes payable 119,640
Cash 200,000
Notes payable 600,000

Entry to record annual amortization:

Amortization expense - franchise 68,036

Accumulated amortization - franchise 68,036.00

Entry to record franchise fee paid to franchisor (as a percentage of revenue):

Franchise fee expense 255,000

Cash 255,000

PATENT

Cost of patent, 1/1/2019 127,500

Less: accumulated amortization 10,625 Based on the shorter of useful life or legal life (12 years)
Carrying value, 12/31/2019 116,875

Research and development costs prior to capitalization:

Research and development costs 650,000

Cash/Various accounts 650,000

At January 1, 2019:

Patent 127,500
Cash 127,500

To record annual amortization:

Amortization expense - patent 10,625

Accumulated amortization - patent 10,625

TRADEMARK

Cost of patent, 9/1/2019 350,000

Not amortized, but only tested for impairment at least annually. (no indications of impairment)

At September 1, 2019:

Trademark 350,000
Cash 350,000

Entry to record the successful defense of trademark:

Legal fees expense 120,000

Cash 120,000
Treated as expenses whether the defense is successful or not.

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B. Accounting for Various Expenditures on Intangible Assets

PALAWAN, Inc. developed a new product to be sold to its customers. The following costs
were incurred in developing, patenting and manufacturing the product:

Fees paid to experts and other parties for research and feasibility P 250,000 Exp
Professional fees to consultants to conduct market analysis 300,000 Exp
Cost of laboratory equipment and facilities for research 800,000 PPE
Cost of initial samples produced during the test run 150,000 Exp
Development costs after determination of technological feasibility 600,000 IA
Patent registration fees 50,000 IA
Fees paid to artists for the drawings required to be submitted
together with the patent application 25,000 IA
Legal fees paid to obtain patent 150,000 IA
Legal fees from successfully defending the patent 100,000 Exp
Cost of competing patent purchased to sustain the economic
benefits from the existing patent 75,000 Exp
Total manufacturing costs incurred during production 3,500,000 Invty

Additional information: The laboratory equipment & research facilities have a useful life
of 10 years.

2. How much should be capitalized as intangible assets? P 825,000

3. How much should be recognized as expenses? P 955,000

C. Subsequent Measurement of Intangible Assets

On December 31, 2018, BAGUIO, Inc.’s patent had a carrying amount of P700,000. The
patent was acquired on August 17, 2016 and has an estimated total useful life of ten years.
Subsequent transactions and relevant information relating to the patent are as follows:

• On January 15, 2019, BAGUIO was sued for allegedly copying the technology of
another party. It spent P95,000 for successfully defending itself in the case.

• At the beginning of 2021, BAGUIO incurred additional costs of P178,000. It is

expected that future economic benefits will flow to the enterprise as a result of this
expenditure through a substantial cost saving and the patent is expected to be useful
until December 31, 2027

• The company’s policy is to take a half-year amortization in the year of acquisition

and another half-year in the year of derecognition using the straight-line method.
The company reports on calendar year basis.

4. How much is amortization expense for 2019? P 93,333

5. How much is the amortization expense for 2021? P 98,672
6. How much is the patent’s carrying value on December 31, 2024?

P 691,334 x 3/7 = P 296,286 (remaining life of the patent)

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PROBLEM C:

Cost of patent 933,333 Gross up (CV divided by 75%)

Less: accumulated amortization 233,333 Age of patent was 2.5 years old (25% of the total cost)
Carrying value, 12/31/2018 700,000 Given in the problem.

Carrying value, 1/1/2019 700,000

Less: amortization for 2019-2020 186,667 Based on cost divided by useful life of 10 years.
Carrying value, 12/31/2020 513,333
Add: subsequent expenditures 178,000 Capitalized due to the improvement it made on the asset.
Revised cost to be amortized 691,333
Divided by: revised useful life 7 From January 1, 2021 - December 31, 2027.
Revised annual amortization 98,762

D. Accounting for Computer Software

ISABELA, Inc. develops computer software for licensing or rental to others. The
capitalized cost of the computer software amounted to P1,500,000 with an economic life
of 5 years. Expected total sales from the software is P7.5 million with an expected pattern
of revenue realization as follows: 35% in Year 1, 20% each year from Years 2 to 4; and
10% in Year 5.

At the end of Year 1, the software has a recoverable amount equal to 90% of the capitalized
cost.

7. How much is the amortization expense for Year 1?

8. How much is the impairment loss for Year 1?

PROBLEM D:

Amortization based on straight-line method 300,000 Cost of P1,500,000 divided by useful life of 5 years.

Carrying value, end of year 1 1,200,000

Recoverable amount, end of year 1 1,350,000 90% of capitalizable cost.
Impairment loss - No impairment is assessed since CV < recoverable amt

The use of percentage of revenue as a method of amortization for intangible assets is only allowed
if the entity can prove the high correlation between the usage of the intangible asset (and
subsequently, the economic benefits that can be derived from the asset) and the revenue generated
from the asset.

Otherwise, the expected pattern of economic benefits shall be assumed to be using the straight-
line method.

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E. Impairment of Various Intangible Assets

On December 31, 2018, BORACAY, Inc. acquired the following intangible assets:

• A trademark for P3,000,000. The trademark has 8 years remaining in its legal life;
however, it is anticipated that the trademark will be renewed in the future,
indefinitely, without problem.

• A patent for P2,000,000. Because of the market conditions, it is expected that the
patent will have an economic life of just 5 years, although the remaining legal life
is 10 years.

Because of the decline in the economy, the trademark is now expected to generate cash
flows of just P120,000 per year. The useful life of the trademark still extends beyond the
foreseeable future. Meanwhile, the cash flows expected from the patent are P300,000 in
2020, P500,000 in 2021, P200,000 in 2022, and P350,000 in 2023.

The appropriate discount rate for all intangible assets is 6%. Round off any present value
factors to two decimal places.

9. How much is the impairment loss for all intangible assets in 2019? P 1,428,500

PROBLEM E:

TRADEMARK

Carrying value, 12/31/2019 3,000,000 With indefinite useful life; not amortized, but tested for impairment.
Recoverable amount, 12/31/2019 2,000,000 Annual cash flows divided by the discount rate (for indefinite useful life)
Impairment loss on trademark 1,000,000

PATENT

Carrying value, 12/31/2019 1,600,000

Recoverable amount 1,171,500 Present value of future cash flows to be generated from the patent
Impairment loss on patent 428,500

F. Accounting for Goodwill

MISIBIS, Inc. has been experiencing significant losses in prior years. On December 31,
2019, the carrying amounts of assets and liabilities are as follows:

Cash P 5,000,000
Accounts receivable 10,000,000
Inventory 15,000,000
Property, Plant and Equipment 20,000,000
Intangible Assets 5,000,000
Goodwill 4,000,000
Liabilities 20,000,000

On December 31, 2019, the fair value of net assets of MISIBIS, excluding goodwill, is
P36,500,000.

10. How much is the impairment loss applicable to goodwill?

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PROBLEM F:

Fair value of net assets, without goodwill 36,500,000

Carrying value of net assets, without goodwill 35,000,000 Identifiable assets less identifiable liabilities
Implied value of goodwill 1,500,000 Recoverable amount of goodwill
Goodwill recorded on the books 4,000,000 Carrying value of goodwill
Impairment loss on goodwill 2,500,000

G. Subsequent Measurement of Goodwill

On January 1, 2019, MANILA, Inc. purchased Makati, Inc. for P25,000,000 when Makati’s
net assets had a fair value of P21,000,000. The excess payment was appropriately
recognized as goodwill and is expected to benefit MANILA for a period of 10 years. During
2020, MANILA spent an additional P2,250,000 for maintaining its goodwill. Due to these
expenditures, at December 31, 2016, MANILA estimated that the benefit period will be
extended by 10 years more.

11. How much is the goodwill to be reported at the December 31, 2016 Statement of
Financial Position?

PROBLEM G:

Consideration paid by Manila 25,000,000

Fair value of net assets acquired by Manila 21,000,000
Goodwill arising from acquisition 4,000,000

Subsequent expenditures on goodwill are always expensed as incurred.

H. Accounting for Cash Generating Units

CAVITE, Inc. acquired another entity on January 1. As part of the acquisition, P5 million
in goodwill was recognized. This goodwill was assigned to one of the acquiree’s cash
generating units (CGUs). During the year, the CGU reported a net earnings of P5 million.
Publicly traded companies with operations similar to those of the CGU had a price-to-
earnings ratio of 1.6 times. The book value of the assets and liabilities of the CGU are as
follows:

Cash P 2,000,000
Accounts Receivable 1,500,000
Property, Plant and Equipment 5,000,000
Investment in Subsidiary 4,000,000
Intangible Assets 2,500,000
Goodwill 5,000,000
Liabilities 4,000,000

12. How much of the carrying value of the Property, Plant and Equipment after the
recognition of impairment?
13. How much is the impairment loss allocated to Intangible Assets?

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PROBLEM H:

Recoverable amount of the cash generating unit 8,000,000 Earnings of P5,000,000 multiplied by P/E ratio of 1.6x
Carrying value of the cash generating unit 20,000,000 Total assets only, including goodwill.
Impairment loss 12,000,000
Impairment loss attributable to goodwill 5,000,000 Allocate first the impairment loss to any available goodwill balance
Impairment loss attributable to other assets 7,000,000 Allocated to the other non-financial assets of the CGU based on carrying values.

Allocation schedule:
CV, before Share in impairment loss (P7M) CV, after
impairment Ratio Amount impairment
Property, plant and equipment 5,000,000 0.43 3,043,478 1,956,522
Investment in subsidiary 4,000,000 0.35 2,434,783 1,565,217
Intangible assets 2,500,000 0.22 1,521,739 978,261
11,500,000 7,000,000 4,500,000

Notes:

a. No allocation of impairment to cash, accounts receivable, and other financial assets

because it is not covered by PAS 36, Impairment of Assets (Covered by PFRS 9, Financial
Instruments).
b. No allocation of impairment to inventories, even if it is a non-financial asset, because it is
not covered by PAS 36 as well. (Covered by PAS 2, Inventories)

14. Assuming that the recoverable amount of the Intangible Assets is P2,200,000, how
much is the carrying value of the Investment in Subsidiary after the allocation of
impairment loss?

Allocation schedule:
CV, before Share in impairment loss (P7M) CV, after
impairment Ratio Amount impairment
Property, plant and equipment 5,000,000 0.56 3,722,222 1,277,778
Investment in subsidiary 4,000,000 0.44 2,977,778 1,022,222
Intangible assets 2,500,000 300,000 2,200,000
11,500,000 7,000,000 4,500,000

Notes:

a. The carrying value of the non-financial asset after the allocation of impairment should
not be lower than its recoverable amount. In this case, since the result of the previous
allocation will make the carrying value of the intangible asset lower than its recoverable
amount of P2.2 million, it will only absorb an impairment equal to the difference between
its carrying value and recoverable amount.

b. The remaining impairment loss (P6.7 million) will now be allocated to PPE and investment
in subsidiary based on their respective carrying values.

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Assume that instead of Goodwill, the CGU has a share in the EDP server amounting to
P2,500,000. The EDP server is used by all CGUs within the company and is therefore
classified as a Corporate Asset.

15. How much of the carrying value of the Property, Plant and Equipment after the
recognition of impairment?
16. How much is the impairment loss allocated to Intangible Assets?

Allocation schedule:
CV, before Share in impairment loss (P12M) CV, after
impairment Ratio Amount impairment
Property, plant and equipment 5,000,000 0.30 3,636,364 1,363,636
Investment in subsidiary 4,000,000 0.24 2,909,091 1,090,909
Intangible assets 2,500,000 0.15 1,818,182 681,818
Share in corporate assets 5,000,000 0.30 3,636,364 1,363,636
16,500,000 12,000,000 4,500,000

Notes: Share in corporate assets (e.g. EDP system) shall be considered in determining the
allocation ratio.

17. Assuming that the recoverable amount of the Intangible Assets is P2,200,000, how
much is the carrying value of the Investment in Subsidiary after the allocation of
impairment loss?

Allocation schedule:
CV, before Share in impairment loss (P11.7M) CV, after
impairment Ratio Amount impairment
Property, plant and equipment 5,000,000 0.36 4,178,571 821,429
Investment in subsidiary 4,000,000 0.29 3,342,857 657,143
Intangible assets 2,500,000 300,000 2,200,000
Share in corporate assets 5,000,000 0.36 4,178,571 821,429
16,500,000 12,000,000 4,500,000

Notes:

a. The carrying value of the non-financial asset after the allocation of impairment should
not be lower than its recoverable amount. In this case, since the result of the previous
allocation will make the carrying value of the intangible asset lower than its recoverable
amount of P2.2 million, it will only absorb an impairment equal to the difference between
its carrying value and recoverable amount.

b. The remaining impairment loss (P11.7 million) will now be allocated to PPE, investment
in subsidiary, and the CGU’s share in corporate assets based on their respective carrying
values.

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I. Computation of Goodwill on Acquisition

BULACAN, Inc. is contemplating to acquire Pampanga, Inc. on January 1, 2019. The

information on Pampanga’s profit and net assets for the past five years are as follows:

Profit Net Assets

2014 P4,000,000 P20,200,000
2015 3,200,000 20,000,000
2016 3,000,000 18,500,000
2017 3,800,000 17,900,000
2018 2,500,000 15,600,000
Total P16,500,000 P92,200,000

Additional information: The fair value of Pampanga’s net assets as of January 1, 2019 is
P18,000,000.

PROBLEM I:

Cumulative earnings 16,500,000 Sum of Pampanga's total earnings

Divided by: No. of years 5 in years
Average earnings 3,300,000
Normal return on net assets 1,620,000 Fair value of net assets x normal rate of return
Average excess earnings 1,680,000

Notes:

a. Previously, we understood goodwill as the excess of the consideration paid by the

acquiring entity over the fair value of net assets acquired. However, in this scenario
called direct valuation, the acquiring entity measures the acquired entity’s earning
capacity as a measure to determine how much goodwill can be recognized from the
acquisition.

b. In determining the cumulative earnings, deduct from the annual earnings any infrequent
gains (e.g. gain on expropriation, gain on sale of long-term assets) and add back any
infrequent losses (e.g. loss on typhoon, loss on fire). Goodwill is measured based on the
entity’s normal earning capacity.

c. Normal rate of return is used rather than the acquiring company’s perceived or
forecasted return on investment after acquisition.

18. Assume that BULACAN will purchase five years’ worth of excess earnings. The
normal rate of return is 9% but BULACAN believes it can earn 14% annually on
its investment in Pampanga due to the latter’s excellent reputation. How much is
the goodwill to be recognized under the “years’ multiple of excess earnings”
method?

Average excess earnings P 1,680,000 x 5 years = Goodwill of P8,400,000

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19. Assume that Pampanga’s excess earnings are expected to continue over a five-
year period and the normal rate of return is 9%. Assume a discount rate of 14%.
The present value of an ordinary annuity of 1 at 14% for five periods is 3.43. How
much is the goodwill to be recognized under the “present value” method?

Average excess earnings P 1,680,000 x PV factor of 3.43 = Goodwill of P5,762,400

20. Assume that BULACAN is willing to pay for goodwill measured by capitalizing at
40% excess of the average profits over the normal return on net assets. The
normal return on net assets for the industry to which Pampanga belongs is 9%.
How much did BULACAN pay to acquire Pampanga, Inc.?

Average excess earnings P 1,680,000

Divide: Capitalization rate 40%
Goodwill arising from acquisition P 4,200,000
Add: Fair value of net assets to be acquired 18,000,000
Consideration to be paid by BULACAN P 22,200,000

If fair value of net assets is not available, the carrying value of net assets may be used.

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