Depreciation (or depletion and amortization) is a process

of allocating the cost of tangible assets in a systematic and

ACCT 5120 rational manner to periods expected to benefit from the
use of the asset. Allocating the costs of long-lived assets
Lecture Notes Ch. 11 FINAL takes three forms:
• Fixed assets = Depreciation expense (Ch. 9)
Note: Intangible assets contain no physical properties • Natural resources = Depletion expense (Ch. 10)
• Intangibles = Amortization expense (Ch. 11)
Amortization of Intangible Assets: Overview
 R&D: expensed as incurred because the value of the
GAAP requirement
benefits to be derived is uncertain unless the expenditure
has an alternative future use (e.g., R&D facility can be
Purchased intangibles
used as an administration building) include all costs
 Definite life (or “finite life” or “limited life”) as set forth in law necessary to acquire and
or contract: cost of intangibles acquired from others* are prepare the asset for use
amortized over the predetermined life of asset**
- Patents – if developed internally, then cost and
amortization are limited to registration fees, attorney’s 20 years from date of filing
Be careful!
fees, etc. Life span laws
- Copyrights – if developed internally, then cost and Life of creator plus 70 years of Patents and
Copyrights are
amortization are limited to same fees as above complicated!
- Franchise fees in excess of services rendered by the Life of franchise contract

franchisor
 Indefinite life: no amortization but written down if Book Value > Fair Value***
- Trademarks – if developed internally, then cost is No amortization with
trademarks because legal
limited to same fees as above (all advertising costs are life can normally be
expensed as incurred even if the value of the trademark renewed indefinitely
has increased)
- Goodwill = purchase price in excess of FMV of net assets Pertains to the purchase
of another business or a
acquired from others segment of a business
 Organization costs of a new firm, including incorporation fees and
filing fees, are normally expensed as incurred
Footnotes:
* Unless acquired from others, intangible assets developed internally should be expensed as incurred
with certain exceptions as noted Note: Useful life equals
economic life or legal life
**Cost of an intangible asset should not be amortized unless its useful life can be determined whichever is shorter
*** All intangibles with indeterminate lives, such as Goodwill, must be tested annually for impairment

Internally generated intangibles – R&D, advertising, etc., often represent significant value to the
Skim company, yet are not shown on the B/S because future benefits are not assured. Therefore, internally
generated intangibles are recorded at cost and expensed as incurred. Only direct costs incurred in
developing intangibles, such as legal costs, are capitalized

Carrying amount of an
intangible equals total
acquisition cost minus
related amortization

Costs of defending
a limited-life
intangible (if
successful) are
capitalized and
amortized over the
remaining useful
life of the asset
 Company purchases a patent ($40K) and a trademark ($60K) from an
Always use the
external, third-party. The patent carries a legal life of 14 years and an shorter of the two
economic life of 10 years.

Note: No “Accumulated
Amortization” Account!
Amortization expense usually reported on I/S as part of SG&A (operating expense)

Summary

Either account is acceptable

In Class Exercise: BE 11-1

Questions: 2, 3, 4
CPA MC #118, #119, #120, #121

New Topic Types of Intangible Assets

 Marketing-related: Trademarks - capitalize acquisition costs; no amortization.
(In the US, trademarks have legal protection for an indefinite number of ten-year renewal periods .)
 Artistic-related: Copyrights - Capitalize costs of acquiring and defending; amortize to expense
over useful life. (Examples: Plays, literary works, musical works, pictures, photographs, videos, etc. )

 Customer-related: Customer lists, Order backlogs – capitalize acquisition cost;

amortize to expense over useful life Client lists (“book of business”) often
a major intangible asset of a CPA firm
 Contract-related: Examples – franchise / licensing agreements, construction permits, broadcast
rights, service, or supply contracts, etc.
- Franchise (or license) with a limited life should be amortized to expense over
the life of the franchise
- Franchise with an indefinite life should be carried at cost and not amortized

 Technology-related: Examples – patents, trade secrets granted by U.S. Patent and Trademark Office
- Patent gives holder exclusive use for 20 years
- Capitalize costs of purchasing a patent
- Expense any R&D costs in developing a patent
- Amortize over legal life or useful life, whichever is shorter

In Class Exercises:
BE 11-2, BE 11-3, BE 11-4,
BE 11-9. Questions: 7, 8, 9,
10. CPA MC #122, #123.
New Topic Accounting and Recording Goodwill
 Capitalize the excess of purchase price of another company over the FMV Note: Internally-created goodwill
of the purchased net assets (= assets purchased minus liabilities assumed) should not be capitalized.
 No amortization permitted because of the indefinite life of the Goodwill asset
 Goodwill subject to an “impairment” test because of its indefinite life
Usually independent, certified appraisers conduct the impairment review
 Any impairment loss is reported as a component of income from continuing operations
 Carrying amount of the related Goodwill asset is reduced accordingly
Dr, Loss on Impairment of Goodwill
Cr, Goodwill
Goodwill can be generated only through the acquisition (purchase) of another business or
segment of a business. Goodwill is not based on expenditures for public relations, advertising,
charitable giving in the community, etc. Such costs must be expensed against earnings as
incurred and are never treated as assets because their future value is not assured.
Value assigned to Goodwill
 Again, Goodwill should not
be amortized. Its carrying
value should be adjusted
only when impaired. (See
next section below.)

In Class Exercises: BE 11-5

Questions: 5, 12, 13.
CPA MC #124.
New Topic Impairment of Intangible Assets
 Impairment of Limited-Life Intangibles: Similar to impairment of long-lived assets in Ch. 10
- If the sum of the expected future net cash flows (undiscounted) is less than the carrying
amount of the asset, an impairment has occurred (known as the “recoverability test”)
- An impairment loss is the amount by which the carrying amount of the asset exceeds the
fair value of the asset (“fair value test” or “impairment test”)
 Any loss is reported as part of Income from Continuing Operations

Illustration: DBA, Inc. has a patent on how to extract oil from shale rock. Unfortunately, several recent non-shale
oil discoveries adversely affected the demand for shale-oil technology. As a result, when DBA performs a
recoverability test, it finds that the expected future net cash flows from this patent are $35 million. DBA patent
has a carrying amount of $60 million. Discounting the expected future net cash flows at its market rate of interest,
DBA determines the fair value of its patent to be $20 million. Perform the recoverability and fair value tests.
ASSETS HELD
FOR USE

FMV or PV of FCF
(-) Net Carrying Value
Impairment Loss
1. Write asset down
2. Depreciate new cost
3. Restoration not permitted

ASSETS HELD
FOR DISPOSAL

FMV or PV of FCF
(-) Net Carrying Value
Impairment Loss
+ Cost of disposal
Total Impairment Loss
1. Write asset down
2. No depreciation taken
3. Restoration is permitted

Restoration of a previously
recognized impairment loss
may not be recognized
unless the asset is held for
 Impairment of Indefinite-Life Intangibles (Other than Goodwill)
disposal.
 - Should be tested for impairment at least annually
- Impairment test is a fair value test Recoverability test not used

- If fair value is less than the carrying amount, an impairment loss is recognized

Illustration: WHAM Radio purchased a broadcast license for $2,000,000. WHAM Radio has renewed the license
with the FCC twice, at a minimal cost. Because it expects cash flows to last indefinitely, WHAM reports the license
as an indefinite-life intangible asset. Recently the FCC decided to auction these licenses to the highest bidder
instead of renewing them. WHAM Radio expects reduced cash flows for the remaining two years of its existing
license. It performs a fair value test and determines that the fair value of the intangible asset is $1,500,000.

Fair Value Test only Carrying amount of broadcast license $2,000,000

(One Step Process)
Less: Fair value of broadcast license A qualitative assessment 1,500,000
reduces cost/complexity
Loss on impairment $ 500,000

In Class Exercises: BE 11-6,

New Topic Impairment of Goodwill BE11-10. Questions: 15, 16, 17.

Two Step Process:

Step 1: If fair value is less than the carrying amount of the reporting unit Fair value often determined
(including Goodwill), then perform Step 2 to determine possible impairment. by someone accredited in
business valuation (See
Step 2: Compare the implied fair value of the Goodwill (from Step 1) to its AICPA “ABV” credential)
carrying amount and recognize any impairment loss.

Illustration: Beast Mode Construction purchased one division, Buck Products, four years ago for $2 million.
Beast Mode management is now reviewing the division for purposes of recognizing an impairment. This
illustration lists the Buck Division’s net assets, including the associated goodwill of $900,000 from the purchase.

Cash There is no impairment

$ if the fair value of the
net assets exceeds their
2
carrying amount
0
0
, However, assume that
0 the fair value of Buck
0 Division is $1,900,000
0
Illustration: Prepare the journal entry (if any) to record the impairment.
Accounts receivable 300,000
Step 1: The fair value of the reporting unit is below its carrying value. Therefore, an impairment has occurred.

Step 2: Confirm the fair value of the goodwill and compare to carrying amount.
Assumes all assets and liabilities
Fair value $1,900,000 other than Goodwill have been
set at their fair values
Net identifiable assets (including goodwill) (2,400,000)

Loss on impairment ($500,000)

Journal Entry
JE assumes that that the
Dr, Loss on Impairment $500,000 remaining reduction in
the implied fair value of
the reporting unit relative
Cr, Goodwill $ 500,000 to its carrying amount is
attributable to Goodwill

Carrying Value of Goodwill based on its implied value is now $400,000 ($900,000 (-) $500,000 write-down)
Like most intangibles,
Summary once Goodwill is written
down, it stays down.
Type of Intangible Asset Impairment Test
 Limited life Recoverability test, then a fair value test if necessary

Indefinite life other than goodwill Fair value test*

Goodwill Fair value test on reporting unit*

*
An optional qualitative assessment may be performed to determine whether the fair value test needs to be performed.

In Class Exercises: BE11-7,

BE 11-8. Question: 18.
Read

Balance Sheet details typically

shown in footnote disclosures

Note: Impairment losses

reported in a single line item
but impairment losses from
Goodwill reported separately

Balance Sheet
• Reporting is similar to reporting of property, plant, and equipment
• Contra accounts are not normally shown for intangibles
• Companies should report as a separate item all (in one lump sum) intangible assets other than Goodwill
Income Statement
• Report amortization expense and impairment losses other than Goodwill in continuing operations
• Goodwill impairment losses should be presented as a separate line item in the continuing operations section,
unless Goodwill impairment is associated with a discontinued operation
Research and Development (R&D) Costs However, R&D costs of any nature
New Topic
 All R&D costs must be expensed when incurred because the value of the undertakenInonClass Exercise: BE11-10.
behalf of others
through contract are capitalized
benefits to be derived is uncertain and expensed when sold.
- Unless the R&D costs, such as for plant and facilities, allow alternative future uses
- If so, capitalize and depreciate over their useful lives (not the life of the R&D project)
 R&D expenditures frequently result in patents or copyrights and, to a lesser extent, trademarks
- Examples: New product, process, idea, formula, composition, or literary work
 R&D costs may include materials, equipment, and facilities; personnel; purchased intangibles;
contract services; indirect costs (HR, IT, FP&A, etc.)
 Costs not considered R&D
 Routine periodic design changes to old products
 Troubleshooting in production phase
 Marketing research
 Quality control tests

“R”: Basic study in

search of new ideas or
new applications

“D”: Taking research

findings and developing
practical applications

Note: Start-up costs, such as organizational expenses (e.g., legal and

Costs similar to R&D accounting fees), advertising costs, and computer software used to support
SG&A activities are expensed as incurred but are not reported as R&D.
In Class Exercises: BE 11-11, BE 11-12, BE 11-13.
Questions: 20, 21, 23, 24. CPA MC #117, #125, #126.

BRIEF EXERCISE 11.1

Patents................................................................................................................... 54,000
Cash.......................................................................................................... 54,000

Amortization Expense........................................................................................... 5,400

Patents ($54,000 X 1/10 = $5,400)............................................................ 5,400
BRIEF EXERCISE 11.2

Patents................................................................................................................... 24,000
Cash.......................................................................................................... 24,000

Amortization Expense........................................................................................... 8,400

Patents [($43,200 + $24,000) X 1/8 = $8,400]............................................. 8,400

BRIEF EXERCISE 11.4

Franchises............................................................................................................. 120,000
Cash.......................................................................................................... 120,000

Amortization Expense........................................................................................... 11,250

Franchises ($120,000 X 1/8 X 9/12 = $11,250)......................................... 11,250

BRIEF EXERCISE 11.5

Purchase price.................................................................................................. $700,000

Fair value of assets.......................................................................................... $800,000
Fair value of liabilities...................................................................................... 200,000
Fair value of net assets.................................................................................... 600,000
Value assigned to goodwill............................................................................. $100,000

BRIEF EXERCISE 11.6

Loss on Impairment.............................................................................................. 190,000

Patents ($300,000 – $110,000)................................................................. 190,000

Note: An impairment has occurred because expected net future cash flows ($210,000) are less than
the carrying amount ($300,000). The loss is measured as the difference between the carrying amount
and fair value ($110,000).

BRIEF EXERCISE 11.7

Because the fair value of the division exceeds the carrying amount of the assets, goodwill is not
considered to be impaired. No entry is necessary.

BRIEF EXERCISE 11.8

Loss on Impairment ($800,000 – $750,000)......................................................... 50,000

Goodwill.................................................................................................... 50,000
The fair value of the reporting unit ($750,000) is less than the carrying value ($800,000)—an
impairment has occurred. The loss is the difference between the recorded net assets of $800,000
and the fair value of $750,000.

BRIEF EXERCISE 11.9

Carrying Life in Amortization Per Months

Amount Months Month Amortization

Patent (1/1/25) $288,000 96 $3,000 12

Legal costs (12/1/25) 85,000 85 $1,000 1
$373,000

Carrying amount.......................................................................................... $373,000

Less: Amortization of patent (12 X $3,000)............................................... (36,000)
Legal costs amortization (1 X $1,000)............................................ (1,000)
Carrying amount 12/31/25........................................................................... $336,000

BRIEF EXERCISE 11.10

Copyright No. 1 for $9,900 should be expensed and therefore not reported on the balance sheet.

Copyright No. 2 for $24,000 should be capitalized. Because the useful life is indefinite, copyright
No. 2 should be tested at least annually for impairment using a fair value test. It would be reflected
on the December 31, 2020 balance sheet at its cost of $24,000.

BRIEF EXERCISE 11.11

Organization Expense........................................................................................... 60,000

Cash.......................................................................................................... 60,000

BRIEF EXERCISE 11.12

Research and Development Expense.................................................................. 430,000

Cash.......................................................................................................... 430,000
BRIEF EXERCISE 11.13

(a) Capitalize
(b) Expense
(c) Expense
(d) Expense

Questions:
 2. If intangibles are acquired for stock, the cost of the intangible is the fair value of the consideration
given or the fair value of the consideration received, whichever is more clearly evident (general rule
for nonmonetary transactions). Normally the stock price would be more ascertainable.

3. Limited-life intangibles should be amortized by systematic charges to expense over their useful life.
An intangible asset with an indefinite life is not amortized. Because there is no discernible life over which to
amortize the cost of the indefinite life intangible

With a
purchased 4. When intangibles are created internally, it is often difficult to determine the validity of any future
intangible service potential. To permit deferral of these types of costs would lead to a great deal of
the market
determines
subjectivity because management could argue that almost any expense could be capitalized on the
its value. basis that it will increase future benefits. The cost of purchased intangibles, however, is capitalized
because its cost can be objectively verified and reflects its fair value at the date of acquisition.

5. Companies cannot capitalize self-developed, self-maintained, or self-created goodwill. (Advertising,

branding, etc.) These expenditures would most likely be reported as selling expenses.

7. The amount of amortization expensed for a limited-life intangible asset should reflect the pattern in
which the asset is consumed or used up if that pattern can be reliably determined (Why? To
properly match revenues and expenses to periods of time). If the pattern of production or
consumption cannot be determined, the straight-line method of amortization should be used.

8. This trademark is an indefinite life intangible and, therefore, should not be amortized.

9. The $190,000 should be expensed as research and development expense in 2020. The $91,000 is
expensed as selling and promotion expense in 2020. The $45,000 of costs to legally obtain the
patent should be capitalized and amortized over the useful or legal life of the patent, whichever is
shorter.

10. Amortization Expense................................................................................ 35,000

Patents (or Accumulated Patent Amortization).................................... 35,000

Straight-line amortization is used because the pattern of use cannot be reliably determined.

11. Artistic-related intangible assets involve ownership rights to plays, pictures, photographs, and video
and audiovisual material. These ownership rights are protected by copyrights. Contract-related
intangible assets represent the value of rights that arise from contractual arrangements. Examples
are franchise and licensing agreements, construction permits, broadcast rights, and service or
supply contracts.

12. Varying approaches are used to define goodwill. They are:

(a) Goodwill should be measured initially as the excess of the fair value of the acquisition cost over
the fair value of the net assets acquired. This definition is a measurement definition but does
not conceptually define goodwill.
(b) Goodwill is sometimes defined as one or more unidentified intangible assets and identifiable
intangible assets that are not reliably measurable. Examples of elements of goodwill include
new channels of distribution, synergies of combining sales forces, and a superior management
team.
(c) Goodwill may also be defined as the intrinsic value that a business has acquired beyond the
mere value of its net assets whether due to the personality of those conducting it, the nature of
its location, its reputation, or any other circumstance incidental to the business and tending to
make it permanent. Another definition is the capitalized value of the excess of estimated future
profits of a business over the rate of return on capital considered normal in the industry.

A bargain purchase (or negative goodwill) occurs when the fair value of the assets purchased is
higher than the cost. This situation may develop from a market imperfection. In this case, the seller
would have been better off to sell the assets individually than in total. However, situations do occur
(e.g., a forced liquidation or distressed sale due to the death of the company founder), in which the
purchase price is less than the value of the identifiable net assets.
13. Goodwill is recorded only when it is acquired by purchase. Goodwill acquired in a business
combination is considered to have an indefinite life and therefore should not be amortized but
should be tested for impairment on at least an annual basis.

15. Accounting standards require that if events or changes in circumstances indicate that the carrying
amount of such assets may not be recoverable, then the carrying amount of the asset should be
assessed. The assessment or review takes the form of a recoverability test that compares the
sum of the expected future cash flows from the asset (undiscounted) to the carrying Recoverability Test
amount. If the cash flows are less than the carrying amount, the asset has been impaired. The
impairment loss is measured as the amount by which the carrying amount exceeds the fair value Fair Value Test
of the asset. The fair value of assets is measured by their fair value if an active market for them
exists. If no market price is available, the present value of the expected future net cash flows
from the asset may be used. Market Price is determined by either (1) Sales of similar assets or (2) Cost of replacing the asset in question

16. Under U.S. GAAP, impairment losses on assets held for use may not be restored.

17. Impairment losses are reported as part of income from continuing operations, generally in the
“Other expenses and losses” section. Impairment losses (and recovery of losses for assets to be
disposed of) are similar to other costs that would flow through operations. Thus, gains (recoveries of
losses) on assets to be disposed of should be reported as part of income from continuing
operations.

18. The amount of goodwill impaired is $40,000, computed as follows:

Carrying value of net assets.......................................... $1,490,000
Fair value of reporting unit............................................ (1,450,000)
Impaired goodwill.......................................................... $ 40,000

20. (a) Personnel (labor) type costs incurred in R&D activities should be expensed as incurred.
(b) Materials and equipment costs should be expensed immediately unless the items have alternative
future uses. If the items have alternative future uses, the materials should be recorded as
inventories and allocated as consumed and the equipment should be capitalized and
depreciated as used.
(c) Indirect costs of R&D activities should be reasonably allocated to R&D (except for general and
administrative costs, which must be clearly related to be included) and expensed.

21. (a) Expense as R&D.

(b) Expense as R&D.
(c) Capitalize as patent and/or license and amortize.
Also, see Illustration 12-14 (page 21).

23. $585,000 ($400,000 + $60,000 + $125,000).

24. These costs are referred to as start-up costs, or more specifically organizational costs in this case.
The accounting for start-up costs is straightforward – expense these costs as incurred. The
profession recognizes that these costs are incurred with the expectation that future revenues will
occur or increased efficiencies will result. However, to determine the amount and timing of future
benefits is so difficult that a conservative approach—expensing these costs as incurred—is required.

EXERCISE 11.1 (a) 10, 13, 15, 16, 17, 19, 23

(b) 1. Long-term investments in the balance sheet.

2. Property, plant, and equipment in the balance sheet.
3. Research and development expense in the income statement.
4. Current asset (prepaid rent) in the balance sheet.
5. Property, plant, and equipment in the balance sheet.
 6. Research and development expense in the income statement.
7. Charge as expense in the income statement.
8. Operating losses in the income statement.
9. Charge as expense in the income statement.
11. Not recorded; any costs related to creating goodwill incurred
internally must be expensed.
12. Research and development expense in the income statement.
14. Research and development expense in the income statement.
18. Research and development expense in the income statement.
20. Research and development expense in the income statement.
21. Long-term investments, or other assets, in the balance sheet.
22. Expensed in the income statement.

EXERCISE 11.2

The following items would be classified as intangible assets:

Cable television franchises Film contract rights
Music copyrights Customer lists
Goodwill Covenants not to compete
Internet domain name Brand names

Cash, accounts receivable, notes receivable, and prepaid expenses would be classified as current
assets on the balance sheet.

Property, plant, and equipment, and land would be classified as non-current assets in the
property, plant, and equipment section on the balance sheet. (Notes receivable might also be
classified as non-current assets on the balance sheet, if the collection period exceeds one year or
one operating cycle.)

Investments in affiliated companies would be classified as part of the investments section of the
balance sheet.

Research and development costs would be classified as operating

expenses on the income statement.

Discount on notes payable is shown as a deduction from the related notes payable in the
liabilities section on the balance sheet.

Organization costs are start-up costs and should be expensed as incurred and reported in
income.