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. 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. When intangibles are created internally, it is often difficult to determine the validity of any future service potential.
To permit deferral of these types of costs would lead to a great deal of subject- tivity because management could argue that almost any expense could be capitalized on the 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. Companies cannot capitalize self-developed, self-maintained, or self-created goodwill.
These expen- ditures would most likely be reported as selling expenses. Factors to be considered in determining useful life are: a The expected use of the asset by the entity.
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. If the pattern of production or consumption cannot be determined, the straight-line method of amortization should be used.
This trademark is an indefinite life intangible and, therefore, should not be amortized. Amortization Expense 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. 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.
Examples of elements of goodwill include new channels of distribution, synergies of combining sales forces, and a superior management team. 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. 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.
Many analysts believe that the value of goodwill is so subjective that it should not be given the same status as other types of assets such as cash, receivables, inventory, etc. The analysts are simply stating that they believe that presentation of goodwill on the balance sheet does not provide any useful information to the users of financial statements.
Whether this is true or not is a difficult point to prove, but it should be noted that it appears contradictory to pay for the goodwill and then immediately write it off, denying that it has any value.
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 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 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. Under U. GAAP, impairment losses on assets held for use may not be restored. 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.
Research and development costs are incurred to develop new products or processes, to improve present products, or to discover new knowledge. 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. Also, see Illustration page Each of these items should be charged to current operations.
Advertising costs have some minor exceptions to this general rule. However, the specific accounting is beyond the scope of this textbook. 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. There are 30 40 — 10 remaining years for amortization purposes. No entry is necessary. The loss is the difference between the recorded goodwill and the implied goodwill.
Becausethe usefullife is indefinite, copyrightNo. Long-term investments in the balancesheet. Property,plant,and equipmentin the balance sheet. Researchand developmentexpense in the income statement. Currentasset prepaidrent in the balance sheet. Charge asexpensein the income statement. Operatinglosses in the income statement. Not recorded; any costs relatedto creating goodwillincurred internally mustbe expensed. Long-term investments,or other assets,in the balance sheet.
Expensedin the income statement. EXERCISE 10—15 minutes The following items would be classified as an intangible asset: Cable television franchises Film contractrights Music copyrights Customerlists Goodwill Covenants notto compete Internetdomain name Brand names Cash, accounts receivable, notes receivable, and prepaid expenses would be classified as current assets.
Property,plant,and equipment,and land would be classified as non-current assets in the property, plant, and equipment section. Research and development costs would be classified as an operating expense. Discount on notes payable is shown as a deduction from the related notes payable on the balance sheet. Organizationcosts are start-up costs and should be expensed as incurred. Advertising costs in general are expensed when incurred or when first used. The computation of accumulated amortization is as follows.
Alatorre should amortize the franchise over its estimated useful life. Becauseitis uncertainthatAlatorrewillbe able to retainthe franchiseat the end of , it should be amortized over 10 years. These costs should be expensed as incurred. Because the license can be easily renewed atnominalcost , it has an indefinite life.
Thus, no amortization will be recorded. The license will be tested for impairment in future periods. Restoration of any impairment loss is not permitted for assets held for use.
Therefore,an impairmenthasoccurred. Todeterminethe impair- ment amount, we first find the implied goodwill. We then compare this implied fair value to the carrying value of the goodwill to determine the amount of the impairment to record. After a goodwillimpairmentloss is recognized,the adjusted carrying amount of the goodwill is its new accounting basis. Note to instructor:It is importantthat before conductingthe goodwill impairmenttest that all other long-lived assets are evaluated and adjusted for any impairments.
Payable, etc The student must also be alert to the fact that several transactions require that an adjustment of Retained Earnings be made. The problem provides a good summary of accounting for intangibles. Problem Time 20—30 minutes Purpose—to provide the student with an opportunity to compute the carrying value of a patent at three balance sheet dates. Computation of amortization is slightly complicated by additions to the account and a change in the estimated useful life of the patents.
Problem Time 20—30 minutes Purpose—the student determines the cost and amortization of a franchise, patent, and trademark and shows how they are disclosed on the balance sheet. The student prepares a schedule of expenses resulting from the intangibles transactions.
Problem Time 15—20 minutes Purpose—to provide the student with an opportunity to determine income statement and balance sheet presentation for costs related to research and development of patents. The problem calls on the student to determine whether costs incurred are properly capitalized or expensed.
Problem Time 25—30 minutes Purpose—to provide the student with an opportunity to determine the amount of goodwill in a business combination and to determine the goodwill impairment. Problem Time 30—35 minutes Purpose—to provide the student with an opportunity to determine carrying value of intangible assets limited life, indefinite life, and goodwill at two balance sheet dates. The problem also requires students to determine impairments, if necessary on the intangible assets.
The patentwas acquired for manufacturing rights rather than for usein research and development activities. Consequently, the cost of the patentcan be capitalizedas an intangible assetand amortized over its useful life. There is no amor- tization for the goodwill or the trade name, both of which are considered indefinite life intangible assets. Thereis no amortization for the goodwill or the trade name, which are considered an indefinite life intangibles. The student is required to deal with such issues as costs incurred for interest expense during construction, the cost of promotional advertising, and expenditures related to obtaining tenants for a shopping center.
Classification of these items is complicated due to a postponement in the starting of business operations. A challenging and interesting case which should provide good background for a discussion of the theoretical support for capitalizing organization costs. CA Time 25—30 minutes Purpose—to present an opportunity for the student to discuss accounting for patents from a theoretical and a practical viewpoint. The student is also required to commenton the theoretical basis of patent amortization.
Finally the student must determine proper disclosure in the financial statements for a patent infringement suit which is in progress at the balance sheet date. This casechallenges the student to present theoretical support and practical application beyond that presented in the text.
A good case to thoroughly cover research and development costs. CA Time 20—25 minutes Purpose—to provide the student with an opportunity to examine the ethical issues related to expensing research and development costs.
The decision to use debt capital to finance the shopping center was made with full knowledge that interest would accrue during the construction period and add to the total cost of building the center, bringing it to the point at which it would produce revenue. The future income to be generated by the shopping center must have been estimated to be more than sufficient to recover all of the expected costs of building the center and preparing it for occupancy, including interest during the construction period.
In lieu of treating interest during construction as an element of the cost of the physical assets, it can be argued that it represents an element of the general cost of bringing the business to the point of revenue production and should therefore be treated as an organization expense. This view regards interest during construction as just another of the many expenditures that are necessary to acquire and organize the physical assets of a new business but do not attach to any specific assets.
Assignable Chapter 0, a review of the accounting cycle, allows students to refresh their knowledge with reading content, interactive tutorials, and adaptive practice questions. Assignments are also available for exercises, brief exercises, and problems for both granular and comprehensive accounting cycle practice. The videos align with end of chapter content and are available as question assistance as students work through problems in WileyPLUS.
To highlight examples where accounting information is used to support business decision making using data analytics, we have introduced a new Analytics in Action End of Chapter Activity. Donald E. Kieso, Ph. Kieso is currently serving on the board of trustees and executive committee of Aurora University, as a member of the board of directors of Kishwaukee Community Hospital, and as treasurer and director of Valley West Community Hospital.
From to , he served as a charter member of the national Accounting Education Change Commission. Terry D. Warfield , Ph. He received a B. Securities and Exchange Commission in Washington, D.
Exercises Problems 1. Indicate how accounts, 1, 2, 3, 4, 5, 1, 2, 5 1 1, 2, 4, 6, 7, 1A, 2A, 3A, debits, and credits are used 6, 7, 8, 9, 19, 14 5A to record business 21 transactions. Indicate how a journal is 10, 11, 12, 3, 4, 6 2 3, 5, 6, 7, 10, 1A, 2A, 3A, used in the recording 13, 14, 16 11, 12 5A process.
Explain how a ledger and 15, 17 7, 8 3 8, 9, 12 2A, 3A, 5A posting help in the recording process. Prepare a trial balance.
Simple 20—30 2A Journalize transactions, post, and prepare a trial balance. Simple 30—40 3A Journalize transactions, post, and prepare a trial balance. Moderate 40—50 4A Prepare a correct trial balance. Moderate 30—40 5A Journalize transactions, post, and prepare a trial balance. DI PA 4. A T account has the following parts: a the title, b the left or debit side, and c the right or credit side.
The terms debit and credit mean left and right respectively. Heath is incorrect. The double-entry system merely records the dual effect of a transaction on the accounting equation. A transaction is not recorded twice; it is recorded once, with a dual effect. Erica is incorrect.
A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favorable nor unfavorable. The basic steps in the recording process are: 1 Analyze each transaction for its effect on the accounts. The advantages of using the journal in the recording process are: 1 It discloses in one place the complete effects of a transaction.
When three or more accounts are required in one journal entry, the entry is referred to as a compound entry. An example of a compound entry is the purchase of equipment, part of which is paid for with cash and the remainder is on account.
It discloses in one place the complete effects of a transaction. It provides a chronological record of all transactions. The advantage of the last step in the posting process is to indicate that the item has been posted.
The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and define the level of detail that a company desires in its accounting system. The primary purpose of a trial balance is to prove check that the debits equal the credits after posting. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements.
No, Victor is not correct. The proper sequence is as follows: b Business transaction occurs. Accounts Payable Decrease Increase Credit 2. Advertising Expense Increase Decrease Debit 3. Service Revenue Decrease Increase Credit 4. Accounts Receivable Increase Decrease Debit 5. Analyze each transaction. In this step, business documents are examined to determine the effects of the transaction on the accounts. Enter each transaction in a journal.
This step is called journalizing and it results in making a chronological record of the transactions. Transfer journal information to ledger accounts. This step is called posting. Posting makes it possible to accumulate the effects of journalized transactions on individual accounts. The three activities would be recorded as follows: 1.
No entry because no transaction has occurred. An account shows increases and decreases in the item it relates to. An account has a left, or debit side, and a right, or credit side. Debit Credit Jan. Debits Credit Oct. Increase the asset Cash, increase the liability Notes Payable. Increase the asset Equipment, decrease the asset Cash.
Increase the asset Supplies, increase the liability Accounts Payable. Rent Expense Accounts Receivable The general ledger is not a book of original entry; transactions are first recorded in the general journal, then in the general ledger.
No Credit 5. Debit Credit Mar. Debits Credit Apr. No entry—Not a transaction. Prepaid Rent Prepaid Insurance Utilities Expense Account Titles and Explanation Debit Credit Debit Credit Balance Mar.
Savings Bonds—this is a personal transaction. Debits Credits Balance Nov. Cash is increased. Cash is decreased. Cash is decreased or Accounts Payable is increased. Cash is decreased or Notes or Mortgage Payable is increased. Inventory: debit 1. Accounts Receivable: debit 2. Cash and Cash Equivalents: debit Equipment: debit 3. Accounts Payable: credit 3. Cost of Goods debit Sold expense : Interest Expense: debit 4. Sales revenue credit b 1.
Decrease in Salaries and Wages Payable: Cash is decreased credited. Increase in Interest Expense: Cash is decreased credited. Interest Expense: debit 1. Net Product Revenues: credit 2. Cash and Cash debit 2. Inventories: debit Equivalents: 3.
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