CHAPTER 7: AUDIT OF INTANGIBLES

AND OTHER ASSETS

INTERNAL CONTROL OVER INTANGIBLES

The internal control over intangibles has the following objectives:

§ Intangibles are correctly recorded.

§ Acquisitions and disposals of Intangibles are properly authorized.
§ Acquisitions and disposal of Intangibles are for the most favorable price possible.
§ Intangibles are properly recorded, appropriately amortized, and written-down, when
necessary.

CONTROL PROCEDURES OVER INTANGIBLES

The control procedures for intangibles, as a non-current asset is generally similar to the control
procedures for PPE (see previous chapter)

TEST OF CONTROL
The auditors consideration of the client’s internal controls over Intangibles, that is whether to
render test of controls or to do direct substantive testing, is similar to his consideration of the
client’s internal control over PPE (see previous chapter). Where test of controls is to be rendered
the following items are considered:
ü Check authorization of purchase of Intangibles to the board of directors minutes of
meetings, capital expenditure budgets and capital expenditure forms and significant
agreements (contracts) with third parties involved.
ü Check authorization for disposals and write-off of significant Intangibles.
ü Confirm existence of Intangibles register or records which adequately identifies assets.
Ensure register reconciles to ledgers.
ü Check authorization of amortization rates, and particularly changes in amortization
policies.
ü Examine evidence of checking of correct calculation of amortization.
ü Examine evidence of checking of correct testing of intangibles’ impairment, when
necessary.

SUBSTANTIVE TESTING: INTANGIBLES

EXISTENCE/OCCURRENCE AND RIGHTS AND OBLIGATIONS

AUDIT OBJECTIVES:
To determine that intangibles exist and are represented by contractual rights, privileges or
earning power owned by the company.
To determine that the intangibles are owned by the company.

AUDIT PROCEDURES:
 CHAPTER 7: AUDIT OF INTANGIBLES AND OTHER ASSETS

1. Examine documentation supporting intangibles.

a. Government registrations or other documentation, if intangibles are filed to and
approved by the government (patent, copyright and trademark)
b. Documentation (deed of sale, etc.) of acquisition of the net assets of another company
(for acquisitions resulting to goodwill)
c. Contracts, if intangibles are from contractual relations with other parties (franchise and
leasehold)
d. Any purchase agreements if intangibles were acquired through a purchase transaction.
2. Perform analytical procedures.

COMPLETENESS

AUDIT OBJECTIVES:
To determine that all transactions related to intangibles have been properly recorded.

AUDIT PROCEDURES:
1. Evaluate certain expense accounts such as professional fees and taxes and licenses for
capitalizable costs which are expensed for the period.
2. Evaluate dispositions and write off during the year.

VALUATION

AUDIT OBJECTIVES:
To determine that intangibles are stated at cost less amortization less impairement loss,
where necessary as prescribed by applicable PFRS.

AUDIT PROCEDURES:
1. Evaluate amortization policy of the company and verify the computation of the amortization.
2. Test intangibles for any sign of impairment by evaluating whether the intangibles will still
provide future benefits for the company.

SUBSTANTIVE TESTING: OTHER ASSETS

FINANCIAL STATEMENT ASSERTIONS - AUDIT OBJECTIVES

EXISTENCE/OCCURRENCE - To determine that the prepaid expenses or deferred charges carried

forward at the beginning of the period are actually chargeable to the operations of the future
periods and that definite benefits will be received in the future periods from these expenses
carried forward as assets.

COMPLETENESS - To ascertain the correctness of the prepaid or deferred amount at the end of
the period as well as the amount consumed or had expired, if any, during the period under
review.

RIGHTS/OBLIGATIONS - To ascertain the propriety of the amount charged as prepaid expenses

or as deferred charges.

VALUATION/MEASUREMENT - To determine the reasonableness and consistency in amortizing

prepaid expenses and deferred charges to expenses.

PRESENTATION AND DISCLOSURE - To determine proper presentation and classification of

prepaid expenses and deferred charges on the balance sheet.

AUDIT PROCEDURES
The auditor’s primary objective in examining prepaid expenses and deferred charges is to
determine that those items represent proper charges to future operations, and that the
amounts, their allocation to costs and expenses, are reported in accordance with generally
accepted accounting principle applied on a consistent basis. To determine propriety, validity and

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accuracy of these prepayments and deferred charges the following general audit procedures
may be followed.

Prepaid Expenses
Prepayments are commonly made for rent, utilities and other items where the expenditure has
been paid for in the current period, but related to the next period. Prepayments are often
immaterial and reliance is often placed on analytical procedures. There are rarely any controls
over prepayments. Auditors generally are more concerned with the overstatement of assets.
Evidence will include:
• Considering client’s own system (if any) for accounting for prepayments.
• Obtaining a schedule of prepayments, ensuring that it is computed correctly and
comparing it with prior year prepayments and performing other analytical
procedures.
• Test checking a sample of prepayments for correct calculation referring to
supporting documentation.

1. Prepaid insurance
a. Inspect insurance policies a test basis.
b. Review coverage premiums.
c. Vouch premium paid and amounts charged to expense during the year and amounts
prepaid at year-end.

2. Prepaid advertising
a. Examine advertising contracts with advertising agencies and note effective dates
covered by the agreement. Determine propriety of charges in the current year.
b. Test-count undated advertising and sales promotion materials.

3. Prepaid rent
a. Examine signed rental agreement noting the effective dates covered by the
agreement.
b. Vouch total amount paid and compare with provision in the rental agreement.
c. Verify distribution of the prepaid amount to prepaid rent and rental expense by
recalculating the amounts.

4. Prepaid interest
a. Examine loan agreement and vouch interest payments.
b. Verify mathematical accuracy of the computation of interest expense and prepaid
interest.

5. Office supplies
a. Vouch purchases of the office supplies on a test basis.
b. Conduct physical count of supplies inventory on a test basis.

6. Other prepayments
a. Review existence of adequate records and documentation.
b. Evaluate allocation of prepaid expenses between asset and expense accounts.

FINANCIAL ACCOUNTING REVIEW: INTANGIBLES

(Reference: PAS 38, INTANGIBLES; PFRS 3, BUSINESS COMBINATION)

DEFINITION
An intangible asset is an identifiable non-monetary asset without physical substance, and are
held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes.

RECOGNITION
An intangible asset is recognized if, and only if:

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(A) It is probable that future economic benefits that are attributable to the asset will
flow to the enterprise.
(B) The cost of the asset to the enterprise can be measured reliably.

An enterprise should assess the probability of future economic benefits using reasonable and
supportable assumptions that represent management’s best estimate of the set of economic
conditions that will exist over the useful life of the asset.

Under PAS 38, Intangibles are recognized only under the following criteria:
(A) Asset is identifiable – an intangible asset is said to be identifiable if: a) it is
separable from all other assets of the entity, that is can be sold, transferred or
rented out to another party without affecting all other asset or all other operations
of the entity, or; b) it arises from legal rights, whether separable or not.
(B) Probable future economic benefits are expected from the asset.
(C) The company has control both the asset and the future economic benefits.

INITIAL MEASUREMENT
An intangible asset should be measured initially at cost plus directly attributable cost of bringing
the asset to its present condition necessary for use according to management’s intention.
Depending on the mode of acquisition, the acquisition cost shall be as follows:

1. Separate Acquisition:
o For Cash purchase - Purchase price, plus import duties and non refundable
taxes net of discounts and rebates.
o Share Issue/Share-Based Payments – fair value of the shares issued or fair
value of the intangibles received whichever is more clearly determinable.
o Installment basis – at cash price of the intangible asset if determinable. If cash
price is not clearly determinable, the present value/discounted value of the
deferred payment scheme using an appropriate discount rate shall be the
assumed cash price.

2. Business Combination
o Any intangible assets acquired through business combination shall be initially
measured at its determinable fair market value (regardless of future intention
on the asset, that is whether the asset shall be used or simply written-off). This
is to distinguish such identifiable intangible from goodwill that may arise from
the business combination.

3. Exchange
o Exchange with commercial substance – intangible acquired shall be measured at
its fair market value which is assumed to be equal to the fair market value of
the consideration given-up plus cash paid or minus cash received.
o Exchange without commercial substance – intangible acquired shall be
measured at the book value of the consideration given up plus cash paid or
minus cash received. If the asset given-up is impaired, an impairment on the
asset shall be recognized first, before the exchange. Thus, the asset received
shall be measured at book value of asset given-up after impairment plus cash
paid or minus cash received.

4. Grants/Donation
o Intangibles received through grants shall be measured at its fair market value
(fair value approach) or at zero/nominal amount. Similar to PPE acquisition
through grants, if the donor is a non-related party, the transaction results to
income (unless conditional, in which case income is deferred subject to
fulfillment of condition). If the donor is a related party, the transaction is a
capital transaction thus, credited to the appropriate donated capital account
(additional-paid-in capital)

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5. Internally Developed Intangibles

o The cost of internally developed intangibles shall be development costs incurred
after establishing strict compliance with qualification criteria of PAS 38 which
include the following:
i. technical feasibility of completing the intangible asset so that it will be
available for use or sell.
ii. its intention to complete the intangible asset and use or sell it.
iii. its ability to use or sell the intangible asset.
iv. how the intangible asset will generate probable future economic
benefits.
v. the availability of adequate technical, financial and other resources to
complete the development and to use or sell the intangible asset
vi. its ability to measure reliably the expenditure attributable to the
intangible asset during its development.

SUBSEQUENT MEASUREMENT (VALUATION):

COST METHOD
- For Intangibles without definite useful life (including Goodwill): Cost net of
Impairment Loss
- For Intangibles with definite useful life: Cost net of Amortization and
Impairment Loss
*Amortization is based on straight-line method, unless a more systematic
method that reflects how economic benefits shall be derived from the intangible
asset is applicable.
**Impairment loss on an intangible asset is determined the same manner with
that of Impairment loss on PPE under PAS 36 (see FINANCIAL ACCOUNTING
REVIEW: PPE, in the previous chapter).

REVALUATION METHOD
- The intangible asset shall be measured at the balance sheet date at its fair value
minus subsequent amortization and impairment losses.

DISCLOSURE REQUIREMENTS
The financial statements should disclose the following for each class of intangible assets,
distinguishing between internally generated intangible assets and other intangible assets.
a. Useful lives or amortization rates used.
b. Amortization methods used.
c. Gross carrying amount and the accumulated amortization (aggregated with
accumulated impairment losses at the beginning and end of the period).
d. The line item(s) of the income statement in which the amortization of intangible assets
is included.
e. A reconciliation of the carrying amount at the beginning and end of the period showing:
e.1. Additions, indicating separately those from internal development and through
business combination.
e.2 Retirements and disposals.
e.3 Increases or decreases during the period resulting from revaluations and from
impairment losses recognized or reversed.
e.4. Impairment losses recognized in the income statement during the period.
e.5. Impairment losses reversed in the income statement during the period.
e.6. Amortization recognized during the period.
e.7. Net exchange differences arising on the translation of the financial statements of a
foreign entity.
e.8. Other changes in the carrying amount during the period.

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SPECIFIC CONCERNS:

PATENT

INITIAL MEASUREMENT
1. SEPARATELY ACQUIRED – the initial cost of a patent which is separately acquired (e.g.
cash purchase, on account, installment, etc.) shall be measured according to the
previous discussion (see INITIAL MEASUREMENT OF INTANGIBLES in the previous
section)
2. INTERNALLY DEVELOPED – any research and development costs incurred in internally
developing a technology on which a patent is acquired from the government shall be
recognized as outright expense on the period of incurrence. Only the cost of acquiring
the legal right over the patent (e.g. cost of government registration including
professional fees and other related costs) shall be recognized as its initial cost.

BALANCE SHEET MEASUREMENT

1. Cost Model – Cost less periodic amortization and impairment loss. Amortization shall be
over the patents’ useful life or legal life (20 years) whichever is shorter. Patent is the
only intangible asset that always have a definite useful life. If its life is not
determinable, the legal life (20 years) is the assumed useful life.
2. Appraisal/Revaluation Model – At fair market value less subsequent amortization and
impairment loss.

SUBSEQUENT COST AFTER INITIAL RECOGNITION OF PATENT

General rule: Any subsequent costs incurred after initially recognizing a patent are outright
expense under the assumption that such further cost have no enhanced future economic
benefits from the related Patent. For instance, the legal cost incurred in defending a patent in
an infringement suit is necessarily incurred only to bring the patent back to its original working
condition. Thus if the defense is successful, there is no enhanced benefit from it. The cost is
expensed outright while the patent is continuously accounted for as is (e.g. amortized at year-
end). Otherwise if the defense is unsuccessful, such is considered an impairment event, thus
the patent’s carrying value is automatically charged as impairment loss under the assumption
that the unsuccessful defense results to patent having no recoverable value anymore.

Exception to the rule: Any subsequent costs shall be capitalized under the assumption that such
cost shall enhance future economic benefits expected from the original Patent. Thus the cost of
the following are capitalized and with the carrying value of the original patent, amortized over
the original patent’s remaining life (Competing Patent) or where appropriate, the original
patent’s extended remaining life (Related Patent):
a. Competing Patent – protects the original patent. Capitalized under the assumption that
the same enhances benefits from the original patent (e.g. increases expected revenue
or decreases operating costs)
b. Related Patent – extends the useful life of the original patent.

INTERNALLY GENERATED INTANGIBLE: COMPUTER SOFTWARE

INITIAL MEASUREMENT
The cost of an internally developed computer software shall be all development costs incurred
after the establishment of the capitalization criteria of PAS 38 (see discussion above), including
the establishment of the asset’s technical feasibility. For computer software development,
technical feasibility is usually established upon the completion of the software’s detailed
program design. Development costs which are usually incurred after the said detailed program
design completion are the cost of coding the product master and the cost of testing the product
master.

BALANCE SHEET MEASUREMENT

Under the Cost Model, the computer software shall be measured at the balance sheet date at
initial cost less amortization and impairment loss.

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The capitalization of the development costs usually seizes when the computer software is ready
for either internal use or for production and sale, at which point the computer software cost is
now amortized over its expected useful life. If the software is for internal use, the amortization
shall be part of the entity’s operating expense. If the computer software is for production and
sale, the amortization on the software along with additional cost to produce the software for
sale, including the duplication of the product master shall be part of the production cost
(inventory).

Amortization of the computer software shall be under straight-line method, unless a more
systematic method which reflects how future economic benefits (e.g. revenue from the
software) shall be derived from the software is warranted.

FINANCIAL ACCOUNTING REVIEW: GOODWILL

(Reference: PFRS 3, PAS 36)

INITIAL MEASUREMENT
Internally generated Goodwill is not recognized as an asset. Goodwill is recognized only if it
arises from business combination and shall be initially measured based on the following:

A. Indirect Method
Acquisition Cost (of the business’ net assets) XX
Less: Fair Value of identifiable net assets, excluding goodwill (XX)
Goodwill XX

B. Direct Method
a. Purchase of excess earnings: Goodwill = Excess Earnings*#years
b. Present value method: Goodwill = Excess Earnings*PV factor
c. Capitalization of excess earnings: Goodwill = Excess Earnings/Capitalization rate
d. Capitalization of normal/average earnings: Goodwill =
Acquisition Price – (Normal or Average Earnings/Capitalization rate)

Where Excess Earnings is computed as:

§ If Average or Normal Earnings is given as a percentage:
Fair market value of net asset, excluding goodwill XX
Multiply by: (Entity normal earnings % - Industry’s average earnings% ) X%
Excess Earnings XX

§ If Normal Earnings is given in terms of actual historical earnings:

Historical accumulated earnings (usually 5 years) XX
Adjusted for: Non-operating (gains)/losses X(X)
Historical earnings from operations XX
Divide by: number of year (usually 5 years) xyears
Average earnings XX
Add/Ded: Incremental/Decremental expenses/income* X(X)
Entity Average earnings XX
Less: Industry normal earnings (XX)
Excess earnings XX

*Incremental or Decremental expenses/income are items of expenses or income

that will tend to increase or decrease as a result of the business combination.
For instance, depreciation or amortization will tend to increase or decrease after
the business combination depending on whether the fair value of the
depreciable or amortizable assets is higher (increase) or lower (decrease) than
their carrying value. Depreciation or amortization increases or decreases since
after the business combination, the said assets will now be carried in the
acquirer’s books at their fair market values. Special bonuses to key employees
are also expected not to be incurred anymore after the business combination

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since reorganization of the business normally accompanies a business

combination.

SUBSEQUENT MEASUREMENT (VALUATION):

Similar to intangible assets without definite useful life, Goodwill having no definite life shall be
measured at the balance sheet date at cost net of any impairment loss. Since Goodwill is an
asset that has no ability to generate cash flows on its own, and Goodwill is also an asset that
cannot be sold separately, impairment on Goodwill is determined through the cash generating
unit (CGU) to which it is allocated.

IMPAIRMENT LOSS ON GOODWILL

Carrying value of the Cash Generating Unit (including Goodwill) XX
Recoverable Value of the cash generating unit* (XX)
Impairment loss XX
*Higher between the Value in use (present value of remaining future cash flows from
continued use and eventual disposal of the net assets comprising the CGU) and the fair
value less cost to sell of the CGU.

The impairment loss on the CGU shall be recognized as follows:

a. First, against the goodwill attributed to the CGU,
b. If goodwill is not enough, any excess shall be charged to all other assets of the CGU in
the ratio their carrying value before any impairment. In allocating the remaining loss,
the resulting carrying value of all other assets should not result to amounts lower than
the higher between:
- the individual asset’s recoverable value
- zero
c. Note that “other assets” identified to by PAS 36, Impairment refers only to assets within
the scope of the said standards which include: Land, Buildings, Machinery and
equipment, Investment properties carried at cost, Intangible assets, Investment in
subsidiaries, associates and joint ventures carried at cost and assets carried at revalued
amounts under PAS 16, PPE and PAS 38, Intangibles.

This therefore means that the following assets, which are not included in the scope of
PAS 36, should be excluded from the “other assets” that should be impaired if the CGU
to which the said assets belong to is impaired: Inventories (PAS 2), Assets arising from
construction contracts (PAS 11), Deferred tax assets (PAS 12), Assets arising from
employee benefits (PAS 19), Financial assets 9PAS 39) Investment properties carried at
fair value (PAS 40), Agricultural assets carried at fair value (PAS 41) and Noncurrent
assets held for sale (PFRS 5). When the CGU to which the above-mentioned assets is
impaired, the said assets should be remeasured separately using their separate
applicable accounting standards.

RECOVERY OF IMPAIRMENT LOSS ON GOODWILL

Any subsequent recoveries on impairment loss recognized against goodwill in the
previous period shall not be recognized. Any subsequent impairment recovery in goodwill is
considered internally generated, thus is not recognized in accounting as an
identifiable/separable asset.

Subsequent recoveries on impairment loss recognized against a CGU shall be recognized

in the income statement only for the other assets comprising the CGU. In recognizing the said
recovery, the carrying value of the other assets comprising the CGU should not be higher than
the lower between and among:
- the individual assets recoverable value
- the individual assets carrying value had there been no previous impairment.

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DISCUSSION PROBLEMS
CHAPTER 7-PROBLEM 1:

1. In auditing intangible assets, an auditor most likely would review or recomputed

amortization and determine whether the amortization period is reasonable in support of
management’s financial statement assertion of:
a. Valuation
b. Existence
c. Completeness
d. Rights and obligation

2. Examining documentation of the purchase of intangible assets is consistent with the

auditor’s objective of validating the management’s assertion of:
a. Valuation
b. Existence
c. Completeness
d. Rights and obligation

3. When auditing prepaid insurance, an auditor discovers that the original insurance policy on
plant equipment is not available for inspection. The policy’s absence most likely indicates
the possibility of a(n)
a. Insurance premium due but not recorded
b. Deficiency in the coinsurance provision
c. Lien on the plant equipment
d. Understatement of insurance expense.

CHAPTER 7-PROBLEM 2:

The following costs are generally incurred by a newly established entity:

Investment in a subsidiary company P1,500,000

Timberland 2,000,000
Cost of engineering activity required to advance the design of a product to
manufacture stage 120,000
Lease prepayments (6 months rent paid in advance) 60,000
Cost of equipment obtained under finance lease 700,000
Internally generated publishing title 230,000
Costs incurred in the formation of the corporation 90,000
Operating losses incurred in the start-up of the business 560,000
Training costs incurred in start-up of operations 80,000
Purchase of a franchise 1,200,000
Goodwill internally generated 300,000
Cost of testing in search for product alternatives 65,000
Goodwill acquired in the purchase of a business 640,000
Cost of developing a patent 140,000
Legal costs incurred in securing a patent 70,000
Costs of successful legal suit to protect the patent 230,000
Cost of purchasing a patent from an inventor 500,000
Cost of conceptual formulation of possible product alternatives 160,000
Cost of purchasing a copyright 900,000
Research and development costs 340,000
Long-term receivables 310,000
Cost of developing a trademark 61,000
Cost of purchasing a trademark 290,000
Computer software for a computer-controlled machine that cannot operate
without that specific software 130,000

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Operating system of a computer 10,000

Stand-alone application computer software 100,000

How much from the above items should be recognized as intangible assets including goodwill?

CHAPTER 7-PROBLEM 3:

Cloud Nine Corp. has maintained a research and development department to develop new
“know hows” which the company patents from time to time. Moreover, the company also
purchase patents.

The following is a summary of transactions involving patents owned by the company.

a. During 2012 and 2013, Cloud Nine Corp. spent a total of P418,000 and P520,000,
respectively, in developing a new process that was patented (PATENT ABC) on April 1,
2014; additional legal and other costs in registering the patent amounting to P100,000
were incurred.

b. Another patent (PATENT DEF) was developed by Lucky Seven Corp. and was purchased
by the company for P375,000 on December 31, 2015. The remaining legal life of the
patent on the acquisition date was 12 1/2 years.

c. During 2014, 2015 and 2016, research and development activities cost P125,000,
P450,000 and P500,000, respectively were incurred. No additional patents resulted
from these activities.

d. A patent infringement suit brought by the company against a competitor regarding

PATENT DEF was successfully prosecuted at a cost of P42,600 in 2016.

e. On July 1, 2017, PATENT GHI was acquired in exchange of a piece of equipment having
a fair value of P300,000. The company paid additional cash on the exchange at
P50,000. The carrying value of the equipment on July 1, was at P380,000. This patent
is estimated to useful for 16 years.

f. During 2018, the company expended P360,000 on patent development. The company
however is still undecided as to how the patent will generate probable future economic
benefits.

Requirements:
1. What is the total expense related to the patents to be recognized for each year from
2012 to 2018?

2. What is the total carrying value of Cloud Nine patents on December 31, 2018?

CHAPTER 7-PROBLEM 4:

Gary Inc., a manufacturer of rubber materials useful for the manufacture of tires, expended
P1,020,000 in research and development costs which resulted to a new formula which extends
the useful life of its rubber products by 50%. The patent related to the “know how” was
approved and granted by the government in late December of 2014 after payment of the
necessary legal and processing fees at P640,000. The company estimates that it would be able
to benefit from the formula for 10 years, after which competitors are estimated to have come
up with the same formula.

On January 1, 2017, Gary Inc. spent P120,000 to acquire a related patent which successfully
extended the life of original patent for additional 4 years.

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By the end of 2018, the company determined that with the competitor launching a more
superior product, the patent might have been impaired. The company estimates that the
remaining net cash flows from the patent shall be P150,000 for the next three years, the
revised useful life. The appropriate market rate of interest was 8% at this time.

1. What is the amortization expense in each year:

a. 2015
b. 2016
c. 2017
d. 2018

2. What is the recoverable value of the patent at the end of 2018?

3. What is the impairment loss to be recognized in the 2018 income statement?

4. What is the amortization expense in 2019?

CHAPTER 7-PROBLEM 5:

The following information pertains to Colgate Company’s intangible assets:

a. On January 1, 2018, the company signed an agreement to operate as a franchise of

Hapee Inc., for an initial franchise fee of P3,000,000. Of the amount, P600,000 was
paid when the agreement was signed and the balance payable in 4 annual equal
payments at the beginning of each year starting 2019. The agreement provides that
the down payment is not refundable and that no future services are required of the
franchisor. The discount rate appropriate to the agreement is 14% which is the implicit
rate to similar loans. The agreement provides for a 5% continuing franchise fee based
on the revenue of the franchisee. Colgate had a total revenues of P18M in 2018. The
company further estimates that the net future cash flows from continued use of the
franchise is at P250,000 annually.

b. Colgate also incurred P2,600,000 prior to 2018 of experimental and development cost in
its laboratory to develop a patent which was granted by the government at the
beginning of 2018. Legal fees and other costs associated with its registration totaled
P544,000. The company estimates that the useful life of the patent was eight years.

c. A trademark was purchased from another company for P1,000,000 on January 1, 2016.
Expenditures totaling to P326,400 for successfully defending the trademark was
incurred in July 1, 2018. By the end of 2016 and 2017, estimates place future net
annual cash flows from the trademark at P200,000 for its remaining life. By the end of
2018, the estimate had been revised to P80,000 because of a recent technological
development in the industry.

d. The prevailing market rate of interest were at 9%, 9.5% and 10% at the end of 2016,
2017 and 2018, respectively.

Requirements:
Case 1:
Assuming that the intangible assets had the following definite life from date of acquisition:
Franchise, 10 years; Patent, 8 years; Trademark, 10 years: Determine the following:
1. What is the carrying value of the franchise at the end of 2018?

2. What is the carrying value of the patent at the end of 2018?

3. What is the carrying value of the trademark at the end of 2018?

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4. Total expense related to the intangibles in 2018?

Case 2:
Assuming that the intangible assets had the following life from date of acquisition: Franchise,
indefinite; Patent, 8 years; Trademark, Indefinite: Determine the following:
1. What is the carrying value of the franchise at the end of 2018?

2. What is the carrying value of the patent at the end of 2018?

3. What is the carrying value of the trademark at the end of 2018?

4. Total expense related to the intangibles in 2018?

CHAPTER 7-PROBLEM 6:

On January 2, 2018, PJ CORP. is contemplating to acquire all the issued and outstanding
ordinary shares of DA INC. in a business combination accounted for as a purchase. The
recorded assets and liabilities of DA Inc. on said date, follows:

Cash P800,000
Inventory 2,400,000
Property and equipment, net of accum. depn. of P3,200,000 4,000,000
Identifiable intangible assets 800,000
Liabilities (1,800,000)

On January 1, 2018, it was determined that the inventory of DA Inc. had a fair value of
P1,900,000, the property and equipment had a sound value of P4,600,000, and its identifiable
intangibles had a fair value of P1,000,000.

The industry’s average rate of return is at 9%, while the DA Inc.’s normal return is at 12%.

Requirements:
1. Assuming that the company contemplates the acquisition price at P8,000,000, how
much is the goodwill resulting form the business combination?

2. How much is the resulting goodwill and the assumed acquisition price if goodwill is
computed using the “purchase of excess earnings” method over a 10 year period?

3. How much is the resulting goodwill and the assumed acquisition price if the excess
earnings will be capitalized at 12%?

4. How much is the resulting goodwill and the assumed acquisition price if the average
earnings will be capitalized at 10%?

5. How much is the resulting goodwill and the assumed acquisition price if the present
value method is in place and that the prevailing rate of interest is at 10% over the 10
year period excess earnings is expected to be generated?

CHAPTER 7-PROBLEM 7:

Karen Corporation is negotiation with Julius Corp. to purchase all of Julius Corp.’s net assets and
assume all liabilities.

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You have been asked to help develop a tentative offer price which will include the least amount
of goodwill involved (since Karen shall be paying the net assets at FMV plus additional amount
which shall correspond to the goodwill.)

Karen made available to you the following information about the books of Julius Corp.

BV FMV
Current Assets 550,000 700,000
Non-current assets* 2,650,000 **2,800,000
Current and Noncurrent Liabilities 900,000 900,000

Total accumulated Net income from 2014-2018*** 1,800,000

*Book value includes a P200,000 goodwill and P1,500,000 depreciable assets with an average
remaining useful life of 5 years. The balance was attributed to the land whose fair value
approximated its book value.

**Excludes the goodwill.

***Included in the accumulated earnings above is an annual presidents’ bonus averaging to

P50,000 and an gain on sale of equipment in 2016 at P200,000.

The normal earnings of similar companies within the industry is 10%.

You were given the following options by which goodwill shall be computed:
a) Purchase of goodwill in the form of 5 years excess earnings.
b) Capitalize excess earnings at 25%
c) Capitalize average earnings at 10%
d) Present value method assuming current effective rate is at 10% (5 years)

Requirements:
1. Compute for the goodwill under each option above:

2. Compute for the purchase/acquisition price under each option above:

3. What is the best option on the point of view of the acquiring company?

CHAPTER 7-PROBLEM 8:

ABC Corporation acquired the net assets of XYZ Corporation in a business combination for a
total acquisition price of P5M on January 1, 2018. XYZ had four cash generating units with the
following fair values of their attributable identifiable intangibles:
CGU ABC P800,000
CGU DEF 1,500,000
CGU GHI 700,000
CGU JKL 1,000,000

The following information were available about each CGU at the end of the year:
ABC DEF GHI JKL
Cash P50,000 P100,000 P70,000 P150,000
Factory Equipment 100,000 240,000 100,000 200,000
Office Equipment 250,000 490,000 120,000 200,000
Building 500,000 900,000 400,000 700,000
Goodwill ? ? ? ?

Future Net Cash flows 149,726 289,242 76,490 139,425

Average remaining life 10 15 10 12

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The prevailing market rate of interest on this date was 10%.

Requirements:
1. How much is the total goodwill from the initial acquisition of XYZ Corp.?

2. How much in total goodwill should be presented in ABC’s 2018 statement of financial
position?

3. How much is the total impairment loss on goodwill for 2018?

4. What is the carrying value of CGU GHI’s Building as of December 31, 2018?

5. What is the carrying value of CGU JKL’s Building as of December 31, 2018?

CHAPTER 7-PROBLEM 9:

On January 1, 2018 EDD Corp. leased an old building which intends to improve and use for
administrative purposes. The company pays for the lease rights of P300,000 to obtain the
lease. Annual rental for the 10 year lease period is P480,000. No option to renew the lease or
right to purchase the property is given by the lessor.

After obtaining the lease, improvements on the leased building costing P1,200,000 were made
and completed on June 30. The improvement was estimated to be useful for 15 years.

1. What is the total expense (excluding depreciation) in relation to the lease?

2. What is the total depreciation expense, assuming straight line method is in order?

3. What is the depreciation expense on the sixth year assuming that at the beginning of
the 6th year, the lessor granted the company a renewal option for another 10 years and
that it is probable that EDD Corp. will be taking advantage of the said renewal option?

CHAPTER 7-PROBLEM 10:

Musar Corp. has initiated extensive research program to develop a more efficient method of
recording compact discs. Management expects to be able to lease its production facilities, when
completely refined, to the many record-producing companies in the area.

You have been asked to assist in the preparation of financial statements for the year ended
December 31, 2018. Costs related to the project have been accumulated in a master account
identified simply as “Recording” since the beginning of the project in early 2018, as follows:

Debits
P185,000 Equipment purchased for use in many research projects over a five-
year period.
78,000 Salaries of staff working on research project.
17,500 Computer program services purchased through a contract with
another enterprise
24,800 Legal fees related to the patent acquired on the new production
process, which is expected to be useful in producing revenues for
ten years.

Credits
P88,000 Down-payments received from other companies that have
contracted to use the new production process in the future.

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Management has determined that general and administrative expense of P175,500 were
incurred during 2018. Based on the time spent on the various enterprise functions, you
estimate that 25% of this amount relates to research project identified as “Recording”.

Discussions with corporate officials reveal that all long-lived assets are depreciated with a full
year’s amortization taken in the year of acquisition and none in the year of disposal. You
determine that the process began to generate revenue in 2018 and, therefore, the amortization
of the patent should begin this year.

1. How much should be reported as research and development cost in 2018?

2. How much should be reported as amortization expense from any intangible asset in
2018?

3. What is the carrying value of any intangible asset in 2018?

CHAPTER 7-PROBLEM 11:

Bits and Bites Inc. is engaged in developing computer software for various industries. Most of
the computer programmers are involved in developmental work designed to produce software
that will perform fairly specific tasks in a user friendly manner. Extensive testing of the working
model is performed before it is released to production for preparation of masters and further
testing. As a result of careful preparation, Bits and Bytes has produced several products that
have been very successful in the market place. The following costs incurred in 2017 and 2018
are related to a specific software created for retail stores which incorporates a stores sales,
purchases and inventory system in an integrated system:

Salaries and wages of programmers doing research incurred in 2017 P940,000

Expenses related to projects prior to establishment of
technological feasibility by the end of 2017 313,600
Expenses related to projects after technological feasibility has
been established in early 2018 but before software is available for 330,000
production (e.g. cost of coding and testing the product master)
Costs to produce and prepare software for sale in 2018 (e.g. cost of 225,000
duplicating the product master)

Additional data for 2018:

Sales of products for the year P2,000,000
Portion of goods available for sale sold during year 70%

Based on the above and the result of your audit, determine the following:
1. Total amount related to the development of computer software that should be expense
when incurred:

2. Amount to be capitalized as software development cost subject to amortization

3. Cost of ending inventory assuming that the computer software will benefit the company
for 3 years, after which a more superior software would have been created rendering
the developed software obsolete.

4. Cost of ending inventory assuming that the projected revenue from sale of the
computer software over its remaining useful life has been projected as follows: 2019,
P1,500,000; 2020, P500,000.

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CHAPTER 7-PROBLEM 12:

Harry Corp. presented to the following analysis on its prepayments and deferred charges
accounts. Classified as current assets in the Company’s statement of financial position:

Harry Corp.
Prepayments
September 30, 2018

Unexpired Rent P350,000

Unexpired insurance 125,000
Prepaid Advertising Expenses 75,000
Office Supplies 115,000
Advances to Officers 135,000
Idle Office Equipment, NRV 25,000
Bond Redemption Fund 545,000
TOTAL 1,370,000

a) On September 1, 2018, the company leased an office/warehouse building located in

Pangasinan at a monthly rental amount of P20,000 for 1 year. On that date, the Co.’s
unexpired rent;
Rent security Deposit: P50,000
1 Year Rent 240,000
Lease Bonus 60,000
350,000

b) Unexpired insurance refer to the following insurance policies:

Type: Period Covered Premium
Fire Insurance 1/1/18-1/1/19 P50,000
Property Insurance 6/30/18-6/30/19 75,000
125,000

c) On June 1, the Company paid and recorded advertising cost amounting to P75,000 to be
aired everyday over Bombo Radyo Philippines for 6 months.

d) P25,00 worth of office supplies remained in the company as of September 2018

REQUIREMENTS:
1. How much from the prepayments should be reported as expense for 2018?

2. What is the balance of the prepayment account to be presented as current asset in

the 2018 statement of financial position?

3. How should the other items, not classified as prepayment should be reported in the
balance sheet?

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MULTIPLE CHOICE EXERCISES

CHAPTER 7-EXERCISE 1:

The following costs are generally incurred by a newly established entity:

Pre-opening cost of a business facility P250,000

Purchased recipes and secret formulas 150,000
Training, customer loyalty, and market share 140,000
Licensing, royalty, and stand still agreement 300,000
Operating and broadcast rights 112,000
Goodwill purchased in a business combination 500,000
A license to manufacture a steroid by means of a government grant 150,000
Cost of courses taken by management in quality engineering management 450,000
A television advertisement that will stimulate the sales in industry 100,000
Investment in associate 500,000
6 month lease payment in advance 300,000
Cost of equipment acquired through a finance lease 100,500
Internally developed customer list 120,500
Cost incurred in the corporation’s formation and organization 230,000
Operating losses incurred in the start-up of the business 130,000
Initial franchise fees paid 175,000
Continuing franchise fees 50,000
Internally generated goodwill 800,000
Cost of testing in search for a product alternative 125,000
Cost of purchasing a patent from an inventor 137,000
Legal cost in securing a patent 70,000
Legal costs incurred in successfully defending a patent 55,500
Cost of developing brands, mastheads, and publishing title 200,000
Cost of purchasing a trademark 250,000
An operating system of a computer 125,000
Amount paid to a lessor for the exclusive right to rent a facility under an
operating lease agreement for a period of 10 years 100,000
Cost of improvements on a leased facility 250,000

How much from the above items, including goodwill, shall be recognized as intangible assets?
a. 2,394,500 b. 1,944,000 c. 2,064,500 d. 1,874,000

CHAPTER 7-EXERCISE 2:

Doha Corporation was organized in 2017. Its accounting records include only one account for
all intangible assets. The following is a summary of the entries that have been recorded and
posted during the years 2017 and 2018:
Intangibles
7/1/17 Franchise expiring on June 30, 2025 P252,000
10/1 Advance payment on lease expiring on October 1, 2019 168,000
12/31 Net loss for 2017 including incorporation fee, P6,000, and
related legal fees of organizing the business, P30,000 (all
incurred in 2017) 96,000
1/2/18 Acquired patent with a useful life of 10 years 444,000
3/1 Cost of developing a secret formula 450,000
4/1 Goodwill purchased 1,670,400
7/1 Legal fees for successful defense of patent purch on 1/2 75,900
10/1 Research and development costs on a new project 960,000

Required: Ignoring income tax effects, determine the following:

1. The unamortized patent cost at December 31, 2018
a. 399,600 b. 470,880 c. 444,000 d. 394,980

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2. The unamortized franchise cost at December 31, 2018

a. 220,500 b. 189,000 c. 204,750 d. 236,250

3. The amount of prepayments to be reported as of December 31, 2018

a. 147,000 b. 63,000 c. 168,000 d. 126,000

4. The adjusting entries on December 31, 2018, should include a net debit to the retained
earnings account at:
a. 1,778,550 b. 84,000 c. 120,750 d. 132,750

5. As a result of the adjustments at December 31, 2018, the total charges against income
of 2018 should be:
a. 1,681,800 b. 1,645,800 c. 1,195,800 d. 1,682,550

CHAPTER 7-EXERCISE 3:

The accounting records of Alyssa Corp. which was organized in 2017 include only one account
for all intangible assets. The following is a summary of the items debited to the said account in
2017 and 2018:

Date Particulars Amount

Jul. 1, 2017 Franchise (indefinite term) P1,260,000
Oct. 1 Lease advance payments (2-year term, starting 840,000
October 1, 2017)
Dec. 31 Net loss for 2017 including incorporation fees,
P30,000, and related legal fees of organizing the
business, P150,000. 480,000
Jan. 2, 2018 Purchased patent (10 year life) 2,220,000
Mar. 1 Cost of developing a recipe 2,250,000
Apr. 1 Purchased goodwill 8,352,000
Jul. 1 Legal fee for successful defense of the patent
purchased in Jan 1, 2018 379,500

Audit notes:
a. On December 31, 2017, the management estimates that the annual net future cash
flows from the franchise’s continued use was at P180,000. On December 31, 2018, this
estimate was revised due to decline in product demand to P150,000 annually.

b. On December 31, 2018, the estimated annual net future cash flows from the patent’s
continued use was at P337,822 for its remaining life.

c. The prevailing market rate of interest as of December 31, 2017 and 2018 was
consistent at 12%.

Based on the above information and on your audit, answer the following requirements:

1. What is the correct carrying value of the Franchise as of December 31, 2018?
a. 1,200,000 b. 1,250,000 c. 1,260,000 d. 1,310,000

2. What is the correct carrying value of the Patent as of December 31, 2018?
a. 1,998,000 b. 1,800,000 c. 1,900,000 d. 1,880,000

3. What is the total retroactive adjustment to retained earnings beginning in 2018 as a result
of your audit?
a. 585,000 b. 480,000 c. 900,000 d. 420,000

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4. What is the total amount chargeable to expense for the current year (2018) as a result of
your audit?
a. 3,479,500 b. 2,861,500 c. 3,049,500 d. 3,059,500

CHAPTER 7-EXERCISE 4:

The following account balances are excerpt from STU Corporation’s trial balance for the audit
period ended December 31, 2018:
Patents P4,940,000
Licensing agreement 1,680,000
Trademark 1,606,000
Leasehold improvements 1,300,000

Audit notes:
a. Patents for STU’s manufacturing process were acquired January 2, 2018, at a cost of
P3,740,000. An additional amount of P1,387,000 was spent on December 30, 2018, for
repairs on machinery covered by the patents and charged to Patent account. The
repairs were necessarily incurred to bring back the said machinery to its original
working condition. STU uses the straight line method for all depreciation and
amortization. The useful life of the patent is its legal life.

b. On January 1, 2016, STU purchased the Licensing agreement, which was useful for ten
years. The Licensing Agreement account balance included the purchase price of
P2,160,000 and P240,000 cost to train employees at the inception of the licensing
agreement. The license have been amortized over the agreement term which is 10
years.

c. A trademark was purchased by STU for P1,280,000 on July 1, 2016. Expenditures for
the successful litigation in defense of the trademark totaled to P326,000 were paid on
July 1, 2018 and were charged to the trademark account. The trademark was
estimated to have an indefinite life. By the end of 2018, the company estimated to
generate annual net future cash flows from the continued use of the trademark at
P90,000. The prevailing market rate of interest on this date was at 9%.

d. A 10 year non-renewable lease was signed January 3, 2018, for the leased building that
STU used in manufacturing operations. The Leasehold Improvement account includes:
- P900,000 cost of improvements with a total estimated useful life of 5 years,
which was completed on March 1, 2018.
- P400,000 lease bonus paid for the exclusive right to occupy the leased property
for the duration of the lease term without the lessor having the right to lease it
out to other third parties.
- The lease agreement calls for annual payments of P500,000 per year every
December 31. The implicit lease rate is 10%.
Amortization/depreciation is yet to be recognized on lease-related assets.

Based on the above information and on your audit, answer the following requirements:

1. What is the correct carrying value of the Patent as of December 31, 2018?
a. 3,553,000 c. 4,680,000
b. 3,366,000 d. 4,753,000

2. What is the correct carrying value of the Licensing Agreement as of December 31,
2018?
a. 1,536,000 c. 1,728,000
b. 1,334,000 d. 1,512,000

3. What is the total retroactive adjustment to retained earnings in 2018 related to the
Licensing agreements accounts?

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a. 216,000 c. 180,000
b. 192,000 d. none

4. What is the correct carrying value of the Trademark as of December 31, 2018?
a. 1,606,000 c. 1,000,000
b. 1,280,000 d. 768,927

5. What is correct amount to be capitalized as right of use asset (excluding the leasehold
improvement) at the beginning of 2018?
a. 3,072,284 c. 3,472,284
b. 3,242,293 d. None

6. What is the total depreciation to be recognized for 2018 in relation to the lease
agreement (right of use asset and leasehold improvement)?
a. 347,228 c. 497,228
b. 527,228 d. 150,000

CHAPTER 7-EXERCISE 5:

Nicole Corp. holds a valuable patent on a precipitator that prevents certain types of air
pollution. Nicole does not manufacture or sell the products and process it develops. Instead, it
conducts research and develops products and processes which it patents, and then assigns
patents to manufactures on a royalty basis. Occasionally it sells patents. The following
presents the summary of the activities in relation to the aforementioned patent:

2008-2009 Research aimed at the discovery of the new technology P3,840,000

Jan. 5, 2010 Design and construction of a prototype 876,000
Mar. 15 Testing the prototype models 420,000
Jan. 2, 2012 Legal and other professional fees to process the patent
application (useful life is 15 years) 660,000
Dec. 10, 2013 Legal fees paid to successfully defending the device patent 357,000
Jan 3, 2015 Acquisition of a competitive patent aimed at protecting
old patent and increasing expected revenue from the 220,000
original patent.
Jan 5, 2017 Acquisition of the related patent which extended the life
of the patents for additional 3 years 335,000
Dec. 31, 2018 Legal fees paid in unsuccessful patents infringement suit
against a competitor 250,000

Requirements:
1. What is the correct cost of the patent upon initial recognition?
a. 5,756,000 b. 1,916,000 c. 1,040,000 d. 660,000

2. What is the carrying value of the patent on December 31, 2011?

a. 572,000 b. 616,000 c. 660,000 d. 5,468,200

3. What is the amortization expense on the patent in 2015?

a. 20,000 b. 44,000 c. 64,000 d. 65,000

4. What is the carrying value of the patent on December 31, 2015?

a. 640,000 b. 845,625 c. 465,000 d. 440,000

5. What is the amortization expense on the patent in 2016?

a. 68,000 b. 70,000 c. 72,000 d. 75,000

6. What is the carrying value of the patent of December 31, 2017?

a. 800,000 b. 825,000 c. 900,000 d. 925,000

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7. What is the total impairment loss from patent to be recognized in 2018?

a. 700,000 b. 750,000 c. 825,000 d. 850,000

CHAPTER 7-EXERCISE 6:

DEF Corp’s patents had carrying value amounting to P550,000 as of December 31, 2018, before
amortization. All patents were purchased on January 2, 2010, 6 years after their registration.
Thus, these patents are being amortized over their remaining legal life from date of purchase.
Repairs cost made to equipment covered by the patent costing P75,000 were debited to the
account on January 2015. Amortization in 2015-2017 included amortization on the P75,000 for
the remaining life of the relevant patent. It is determined that the P75,000 should have been
expensed in 2015.

It is further determined on December 31, 2018, before any amortization is made, that one of
the patents has a remaining life of only 2 years from the start of the current year. This patent
had an original cost of P210,000.

1. What is the correct amortization expense in 2018?

a. 45,000 b. 68,333 c. 83,333 d. 113,333

2. What is the adjusted carrying value of the patent as of December 31, 2018?
a. 386,667 b. 500,000 c. 550,000 d. 600,000

3. What is the retroactive adjustment to the retained earnings in 2018?

a. 25,000 b. 50,000 c. 55,000 d. 75,000

CHAPTER 7-EXERCISE 7:

The following information pertains to Amfurst Corp.’s ingangibles as of December 31, 2018:
A. On January 1, 2018, Amfurst Corp. signed an agreement to operate as a franchisee of
McDolibee Fastfood Inc. for an initial franchise fee of P3,000,000. P600,000 was paid as
a downpayment with the balance being payable in 3 equal annual payments beginning
January 1, 2019. The agreement provides that the down payment is non-refundable and
that no future services are required of Mcdolibee Fastfood Inc. The prevailing implicit
rate for loans of this type was at 14%. The agreement further provides that 5% of the
revenue from the franchise must be paid to the franchisor annually. Amfurst’s revenue
from the franchise for 2018 was at P12,000,000. The company also estimates that the
net annual cash flows from the franchise agreement shall be P400,000. The prevailing
market rate of interest on December 31, 2018 was at 12%.

B. Amfurst incurred P2,600,000 of experimental development cost for a technology for

which patent was granted by the government on January 2018. Legal fees and other
costs associated with its registration amounted to P545,000. It was estimated that the
patent shall be useful only for eight years. The company estimates that the net annual
cash flows from the patents continued use is at P120,000.

C. Amfurst incurred in 2018 a total of P1,000,000 in relation to a 5-year operating lease

agreement for a building which shall be utilized by the company as a warehouse. The
lease commenced on January 1, 2018. From the said amount, P200,000 covers the first
year of rent; P200,000 is a refundable security deposit; P150,000 is lease rights paid to
have exclusive right to use the building for 5 years, and; P450,000 covers physical
improvements to the building prior to its use. The said physical improvements was
completed by June 30, 2018 and is useful for 10 years.

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Required:
1. Assuming that the franchise agreement is for 10 years from January 1, 2018, what is the
total expense related to the frachise that should be recognized in the 2018 income
statement?
a. 845,731 b. 926,006 c. 1,186,028 d. 1,270,028

2. Assuming that the franchise agreement is for an indefinte term, what is the total expense
related to the franchise that should be recognzied in the 2018 income statement?
a. none b. 600,000 c. 860,023 d. 1,105,753

3. What is the carrying value of the patent as of December 31, 2018?

a. 547,651 b. 476,875 c. 517,750 d. 525,000

4. What is the total amount of expense to be recognized in 2018 in relation to the lease
agreement?
a. 230,000 b. 250,000 c. 280,000 d. 300,000

CHAPTER 7-EXERCISE 8:

During 2018, Sahara Corp. purchased a building site for its proposed research and development
laboratory at a cost of P2,400,000. Construction of the building commenced in 2016. The
building was completed on December 31, 2017, at a cost of P11,200,000 and was placed in
service on January 2, 2018. The estimated useful life of the building 20 years. The company’s
policy is to depreciate the asset using straight-line method to zero residual value.

Management estimates that about 50% of the projects of the research and development group
will result in long-term benefits, that is for at least 10 years, to the corporation. The company,
however, failed to demonstrate how such projects will general the said probable future
economic benefits. The remaining projects either benefit the current period or are abandoned
before completion. The following is a summary of the number of projects and the direct costs
incurred in conjunction with the research and development activities for 2018:

Number Salaries and other Other expenses

of employee benefits (except
Projects depreciation)
Completed projects with 30 P3,600,000 P2,000,000
long-term benefits
Abandoned projects 20 2,600,000 600,000
Projects in progress – 10 1,600,000 480,000
results indeterminate

Upon the recommendation of the R&D Department, the company acquired a patent for
manufacturing rights at a total cost of P3,200,000. The patent was acquired on April 1, 2017,
and is useful for 10 years.

Requirements:
1. What is the carrying value of any capitalizable internally developed intangibles as of
December 31, 2018?
a. 3,600,000 b. 5,600,000 c. 7,680,000 d. none

2. What is the total research and development expense for 2018?

a. 5,840,000 b. 11,760,000 c. 10,880,000 d. 11,440,000

3. What is the amortization expense on the patent for 2018?

a. 160,000 b. 320,000 c. 240,000 d. none

4. What is the carrying value of the building on as of December 31, 2018?

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a. 10,640,000 b. 11,200,000 c. 10,080,000 d. 12,920,000

5. What is the carrying value of the patent on as of December 31, 2018?

a. 2,560,000 b. 2,640,000 c. 3,200,000 d. 0

CHAPTER 7-EXERCISE 9:

Before 2018, Balagtas Enterprises prepared financial statements internally. The company has
not been audited because the ownership is held completely by one family and is not actively
sold. As of 2018, however, in anticipation of bank loans and a possible public offering of
ordinary shares, the company needs audited financial statements prepared in conformity with
GAAP.

As a member of the team of independent auditors responsible for Balagtas Enterprises, you
have been assigned the intangible assets. You have observed that four intangible asset
accounts appear on the unadjusted trial balance.
Franchise 555,000
Organization cost 102,000
Goodwill 342,000

Additional investigation reveals the following:

1. A franchise agreement was signed on January 1, 2018. A P550,000 fee was paid, covering
an indefinite period. The agreement calls for an additional annual payment of 5% of
revenue. An entry debiting the account for P5,000 was made at the time of the cash
payment for 2018 for the continuing franchise fee. At the end of 2018, estimates placed
annual net future cash flows anticipated from the franchise was expected to be at P67,500.
The prevailing market rate of interest on this date was at 15%

2. Organization cost include the unamortized portion of amounts paid to promoters for services
rendered at the inception of the corporation. These fees have been amortized, since
inception, over an estimated 40-year life.

3. The goodwill account includes the following three items:

P45,000 Legal fees relative to the incorporation. These were assigned to the
account on January 2015.
200,000 Excess of cost over assigned net assets’ fair values of an enterprise
acquired at the beginning of 2016, expected to be of value for an
indefinite period.
100,000 Paid to an advertising consulting firm in early 2016 for a major
advertising effort expected to be beneficial for an indefinite period.

Required: Determine the correct balances as of December 31, 2018 of the following:
A B C D
1. Franchise 500,000 450,000 505,000 5,000
2. Organization cost 147,000 102,000 47,000 0
3. Goodwill 185,000 195,000 200,000 345,000

CHAPTER 7-EXERCISE 10:

In line with Can Corp.’s expansion program, it has become interested in acquiring a plant in
Mindanao to handle many of its production functions in that area. One prospective seller is
Mariwasa Co. whose owners have decided to sell their business if a proper settlement can be
agreed upon. Mariwasa Co.’s statement of financial position appears as follows:

Current Assets P9,000,000 Current Liabilities P4,800,000

Investments 3,000,000 Noncurrent Liabilities 6,000,000

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PPE, net 24,000,000 Ordinary shares 3,000,000

Share premium 10,200,000
Accum. profits 12,000,000
Total P36,000,000 Total P36,000,000

Can has hired an appraisal company to determine the proper valuation of its assets and has
ascertained that the investments has a fair value of P9,000,000 while inventories were
understated by P4,800,000. An examination of the company’s income for the last 4 years
indicates that the net income has a steady increase of 20%. Net income in 2017 was at
P6,000,000. The company believes that this trend will continue over the next 4 more years.
Based on industry performance, it is believed that the normal rate of return for businesses
similar to Mariwasa was at 18%. Determine the proposed acquisition price assuming that
goodwill shall be computed as follows:

1. Capitalization of average excess earnings at 18%:

a. 89,680,000 b. 72,000,000 c. 36,572,832 d. 53,680,000

2. Purchase of excess earnings for four years:

a. 48,729,600 b. 39,182,400 c. 61,920,000 d. 45,662,400

3. Capitalization of average earnings at 20%

a. 48,312,000 b. 39,182,400 c. 61,920,000 d. 45,662,400

4. Present value of the average excess earnings for four years at 15%:
a. 63,585,958 b. 55,182,400 c. 45,085,688 d. 45,662,400

CHAPTER 7-EXERCISE 11:

On January 1, 2017, T Corporation acquired M Inc. net assets for a total of P10,000,000. M Inc.
has manufacturing plants in three countries. The fair market values of the identifiable net
assets of the operations from each countries were as follows:
Country A P2,000,000
Country B 1,500,000
Country C 4,500,000

At the beginning of 2018, a new government is elected in country C. It has promulgated a new
legislation significantly restricting exports of T Corporation’s main product. As a result, and for
the foreseeable future, T Corporation’s production in Country C will be cut by 40%. On the same
date, the carrying values of Country C’s net assets were as follows:

Factory Equipment P2,500,000

Store Equipment 1,500,000
Building 2,700,000
Goodwill ?
Payables 700,000

Moreover, the company originally estimated annual future net cash flows from its operations in
Country C at P1,500,000. (assume to include future cash flows in relation to settlements of
country C’s direct liabilities)

T uses straight line depreciation over a-10 year life for the Country C identifiable assets and
anticipates no residual value. It is also estimated that the prevailing market rate of interest
that reflects current market assessments of the time value of money and the risks specific to
Country C cash-generating unit was 15%.

Requirements:
1. How much is goodwill allocated to the CGU Country C upon acquisition?
a. 0 b. 1,125,000 c. 1,500,000 d. 2,000,000

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2. How much is the value in use of the CGU Country C as of January 1, 2018?
a. 4,294,426 b. 4,516,892 c. 7,157,376 d. 7,528,153

3. What is the total impairment loss of the CGU Country C?

a. 2,830,574 b. 1,705,574 c. 1,125,000 d. 0

4. How from the impairment should be recognized against goodwill of CGU Country C?
a. 2,830,574 b. 1,705,574 c. 1,125,000 d. 0

5. What is the carrying value of the CGU Country C’s Building after impairment loss
recognition?
a. 767,508 b. 1,932,492 c. 2,012,679 d. 2,500,000

6. Assuming that Store equipment had fair value less cost to sell of P1,400,000, what is the
carrying value of Building after the impairment loss recognition?
a. 767,508 b. 1,023,344 c. 1,676,656 d. 1,736,655

7. Assuming that Store equipment had fair value less cost to sell of P1,000,000, what is the
carrying value of Building after the impairment loss recognition?
a. 767,508 b. 1,932,492 c. 2,012,679 d. 1,736,655

CHAPTER 7-EXERCISE 12:

ABC Corporation has several cash generating units (CGU). As of December 31, 2018, the
demand for the products produced by one of its cash generating units substantially declined
thus, the cash generating unit was considered for possible impairment. The following were
made available for the said testing:

Asset CV, 12/2018

Factory Equipment P1,750,000
Office Equipment 1,475,000
Building 2,725,000
Goodwill 500,000

As a result of the impairment event, the expected annual net cash flows from the CGU are
expected to be at P1,252,282 for its remaining 5-year useful life. The fair value less cost to sell
of the CGU is at P5,250,000. (Assume a prevailing rate of interest at 8%)

Required:
1. What is the recoverable value of the cash generating unit?
a. 5,000,000 b. 5,250,000 c. 5,500,000 d. 5,750,000

2. What is the impairment loss on the cash generating unit?

a. 1,200,000 b. 1,000,000 c. 950,000 d. 1,450,000

3. What is the carrying value of the Building after the impairment loss recognition?
a. 2,725,000 b. 2,527,000 c. 2,404,412 d. 2,125,000

4. If the factory equipment has a recoverable amount of P1,600,000 and the office
equipment had a recoverable value of P1,400,000, what is the carrying value of the
Building after the impairment loss?
a. 2,270,833 b. 2,368,155 c. 2,250,000 d. 2,000,000

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CHAPTER 7-EXERCISE 13:

Megamall Company’s own research department has an on-going project to develop a new
production process. At the end of 2018, Megamall had already spent a total of P600,000, of
which P540,000 was incurred before November 1, 2018. On November 1, 2018, the company’s
newly developed production process met the criteria for recognition.

At the end of 2018, a reasonable estimate placed the present value of all expected future net
cash flows (including costs to complete) from developed intangible to be at P500,000.

During 2019, Megamall incurred additional expenditure on the project at P1,200,000. At the
end of 2019, the recoverable amount of the intangible asset was estimated to be at P1,140,000,
including future cash outflow to complete the process before it is ready for use.

Requirements:
1. How much from the expenditures above should be expensed in 2018?
a. 600,000 b. 540,000 c. 60,000 d. 0

2. How much from intangible should be reported in the December 31, 2018 statement of
financial position?
a. 600,000 b. 540,000 c. 60,000 d. 0

3. How much from intangible should be reported in the December 31, 2019 statement of
financial position?
a. 1,800,000 b. 1,740,000 c. 1,260,000 d. 1,140,000

4. How much impairment loss from the intangible should be reported in the December 31,
2019 statement of comprehensive income?
a. 0 b. 60,000 c. 120,000 d. 600,000

CHAPTER 7-EXERCISE 14:

The Las Vegas Inc. acquired several small companies at the end of 2018 and, based on the
acquisitions, reported the following intangibles in its December 31, 2018 balance sheet:
Patent P600,000
Copyright 1,200,000
Tradename 1,050,000
Computer software 300,000
Franchise 480,000
Goodwill 2,700,000

Additional information:
a. The patent which had a remaining legal life of 15 years, was purchased from FAC for
P600,000, The company estimates that the patent will be useful in generating the
company cash flows over a ten year period. The patent was carried in FAC’s accounting
records at a net book value of P800,000 when it sold the same to Las Vegas.

b. The company was able to generate approximately P1.5M in 2019 from distribution of
the copyright protected materials. Moreover, the company estimates that P3.5M will be
further generated from the copyrighted materials.

c. The company expects to use the tradename for the foreseeable future.

d. The accountant knows that the computer software is used in the company’s 240 sales
offices. The company has replaced the software in its 100 offices in 2019 and expects
to replace the software in 80 more offices in 2020 and the remainder in 2021.

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e. The franchise was purchased from JC Company. In addition, 5% of revenue from the
franchise must be paid to JC. Revenue from the franchise for 2019 was P2.5M. Las
Vegas Inc. estimates that the useful life of the franchise to be 10 years and takes a full
years amortization in the year of purchase.

f. The company incurred research and development cost in 2019 as follows:

Materials P42,000
Equipment, 4 year useful life 100,000
Personnel 189,000
Indirect costs 102,000
The company estimates that these costs will be recouped by December 31, 2022. The
materials and equipment purchased have no alternative use.

Using the above information, ascertain the following item:

1. What is the amortization expense on the Patent and the Copyright combined in 2019?
a. 574,286 b. 554,286 c. 420,000 d. 400,000

2. How much is the total expense related to the franchise and computer software combined, in
2019?
a. 298,000 b. 273,000 c. 250,000 d. 173,000

3. What is the total research and development expense in 2019?

a. 433,000 b. 358,000 c. 333,000 d. 291,000

4. What is the total intangibles as of December 31, 2019?

a. 5,609,000 b. 5,757,0009 c. 5,737,000 d. 5,582,714

CHAPTER 7-EXERCISE 15:

Bohol Corporation maintain the following items in its Intangibles account as of the fiscal year
ended June 30, 2018:
Intangibles:
Research AM123 P65,650
Copyrights 63,000
Goodwill 32,000

Audit findings:
a) Research AM123 is for a research project which consists of the following charges:

Salaries of research staff P18,500

Patent acquired solely for the use in the project 12,000
Special equipment acquired and useful for
various similar research activities 10,000
Patent acquired for use in several research
projects including Project AM123 16,200
Cost of pilot models 8,950
Total P65,650

The patent have generally been found to be useful for approximately ten years while the
special equipment useful for five years. You have further discovered both patents and
the specialized equipment were acquired at the beginning of the fiscal year, and that
cost of models and salaries were incurred evenly throughout the fiscal year.
Amortization is yet to be made on the related intangible.

b) The company’s copyright were accounted for as follows:

Asset Acquisition Date Useful life Cost
Copyright ABC January 2, 2014 25 years P30,000
Copyright XYC July 15, 2015 15 years 33,000

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You have discovered that the company made no amortizations on the above intangibles
from the year of acquisition.

c) The company’s goodwill was acquired as part of a business combination when it

acquired the net assets of its then rival, Cebu Corp. at an acquisition cost amounting to
P1,582,0000 on February 24, 2016. Cebu’s net assets were carried in its books at
P1,550,000 while their fair value aggregated to P1,560,000.

d) Management has now decided to correct its past accounting treatment deciding to use
the straight line method of amortizing intangibles computed to the nearest half –year.

REQUIREMENTS:
1. What is the carrying value of the following intangibles as of June 30, 2018?
A B C D
a. Project 123 0 10,000 18,950 36,250
b. Patent 23,580 19,800 16,200 14,580
c. Copyrights 50,500 51,000 59,600 63,000
d. Goodwill 0 22,000 32,000 50,000

2. How much should be recognized as research and development expense for the fiscal year
2018?
a. 27,450 b. 37,450 c. 39,450 d. 43,070

3. How much is the amortization expense for the copyrights in fiscal year 2018?
a. 3,400 b. 2,800 c. 2,300 d. 2,000

4. How much is the amortization expense for the goodwill in fiscal year 2018?
a. 0 b. 1,100 c. 1,600 d. 2,000

CHAPTER 7-EXERCISE 16:

The following costs were incurred by Tailor Corp. during 2018:

Searching for applications of new research findings P57,000
Trouble-shooting in connection with breakdowns during commercial
production 87,000
Adaptation of an existing capability to a particular requirement or
customer’s need as a part of continuing commercial activity 39,000
Engineering follow-through in an early phase of commercial production 45,000
Radical modification of the formulation of a glassware production 78,000
Laboratory research aimed at discovery of new knowledge 204,000
Testing for evaluation of new products 72,000
Quality control during commercial production, including routine
testing of products 174,000
Materials consumed in research and development projects 177,000
Consulting fees paid to outsiders for research and projects 300,000
Personnel costs of persons involved in research and devt projects 384,000
Indirect costs reasonably allocable to research and devt projects 150,000
Materials purchased for future research and devt projects 102,000
Research and devt costs reimbursable under a contract to perform
research and devt for Cleint Corporation 1,050,000
Design, construction, and testing of preproduction prototypes and models 870,000
Routine and on-going efforts to refine, enrich, or otherwise, improve upon
the qualities of an existing product 750,000
TOTAL P4,539,000

What is the total amount to be classified and expensed as research and development for 2018?
a. 3,342,000 b. 2,292,000 c. 2,394,000 d. 2,220,000

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