NEW ERA UNIVERSITY COLLEGE OF BUSINESS & ACCOUNTANCY AUDITING PROBLEMS
AUDIT OF INTANGIBLE ASSETS PROBLEMS
AP 006 RSPADERES
INSTRUCTION: ANSWER THE FOLLOWING QUESTIONS PROBLEM 1 The following costs are generally incurred by a newly established entity: Preoperating costs of a business facility Purchased recipes and secret formula Training, customer loyalty and market share Licensing, royalty and standstill agreement Operating and broadcast rights Goodwill purchased in a business combination A license to manufacture a steroid by means of a government grant Cost of courses taken by management in quality engineering management A television advertisement that will stimulate the sales in technology industry Investment in associate 6 month lease payment in advance Cost of equipment acquired through a finance lease Internally developed customer list Cost incurred in the corporation’s formation and organization Operating losses incurred in the start up of the business Initial franchise fees paid Continuing franchise fees Internally generated goodwill Cost in testing in search for a product alternative Cost of purchasing a patent from an inventor Legal cost of securing a patent Legal costs incurred in successfully defending a patent Cost of developing brands, mastheads and publishing title Cost of purchasing the trademark Computer software from a computer-controlled machine that cannot operate without that specific software An operating system of a computer Amount paid to a lessor for the exclusive right to rent a facility under an operating lease agreement for a period of 10 years Cost of improvements on a lease facility REQUIRED: Compute for the total cost of intangible assets. Rspaderes2013
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375,000 225,000 210,000 450,000 168,000 750,000 225,000 675,000 150,000 750,000 450,000 150,750 180,750 345,000 195,000 262,500 75,000 1,200,000 187,500 205,500 105,000 83,250 300,000 375,000 488,250 187,500 150,000 375,000
PROBLEM 2 On January 2, 1011, David Inc,. acquired copyrights to the original recording of a famous singer. The agreement with the singer allows the company to record and rerecord the songs of the singer for a period of 5 years. During the initial 6-month period of the agreement, the singer was very sick and consequently cannot record. The studio time that was blocked by the company had to be paid even during the period the singer could not sing. The following costs were incurred by the company: Legal costs of acquiring the copy rights Documentation expenses related to the copy acquisition Operational costs (studio time lost etc.) Massive advertising campaign to launch the artist
15,000,000 1,500,000 3,000,000 1,500,000
REQUIRED: 1) How much should the copy right be initially recognized? 2) What is the carrying value of the copy right as of December 31, 2011?
PROBLEM 3 Rodiel Inc. acquired the net assets of Ferrer Inc. on June 30, 2011 in a business combination. The cost of the acquisition is P3,000,000 more than the total fair market value of the company’s net identifiable assets. Among the identifiable assets are the following intangibles: Trademark Customer list Franchise
Book value 375,000 750,000 300,000
Fair value 600,000 1,125,000 525,000
Estimated remaining life 4 3 5
REQUIRED: 1) How much is the total intangibles including goodwill to be initially recognized? 2) What is the carrying value of the various intangibles including goodwill on December 31, 2011?
PROBLEM 4 On December 28, 2011, Joseph Corporation was granted by the government licenses to operate radio and television stations over a 10-year period. The fair market value of the similar licenses is at P2,250,000. The company paid professional and other processing fees totaling P75,000. REQUIRED: 1) How much should the license be initially recognized? 2) What is the carrying value of the license on December 31, 2012?
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PROBLEM 5 On December 26, 2011, Zandra Co. obtained franchise from Donde Corp. to sell for 20 years Dondie products. The initial franchise fee as agreed upon shall be P15,000,000 and shall be payable in cash, P1,500,000 when the contract is signed and the balance in five equal installments every December 31, thereafter, as evidenced by a noninterest bearing note. The agreement provides that the franchisor shall provide the necessary initial services required under the franchise contract. By the end of the year, the Company has performed all the initial services which costed Dondie P2,246,592. REQUIRED: 1) How much should the franchise be initially recorded? 2) What is the carrying value of the franchise on December 31, 2012?
PROBLEM 6 John Corp. is developing a new production process. During the year, total expenditure amounted to P1,500,000nof which P1,350,000 was incurred before December 1, 2011 and P150,000 was incurred between December 1 to December 31 of the same year. The entity was able to demonstrate that at December 1, the production process met the criteria for recognition as an intangible asset. The recoverable amount of the know-how embodied in the process (including cash outflows to compute the process before it is available for use) is estimated to be P750,000. During 2012, expenditure incurred is P3,000,000. At the end of 2012, the recoverable amount of the know-how embodied in the process (including future cash outflows to compute the process before it is available for use) is estimated to be P2,850,000. REQUIRED: 1) How much should be the related intangible asset be initially recognized in 2011? 2) How much should be the intangible be recognized as of December 31, 2012?
PROBLEM 7 Llubel Inc. holds a vaiuable patent on a precipitator that prevents certain types of air pollution. Llubel does not manufacture or sell the products and processes it develops. Instead, it conducts research and develops products and processes which it patents, and then assigns patents to manufacture on a royalty basis. Occasionally it sells patents. The following presents the summary of the activities in relation to the aforementioned patent: 2003 01/05/2004 03/15/2004
Research aimed at the discovery of the new technology Design and construction of a prototype Testing the prototype model
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P5,760,000 1,314,000 630,000
01/02/2005 12/10/2007 01/03/2009 01/05/2010 12/31/2012 REQUIRED 1) What is the 2) What is the 3) What is the 4) What is the 5) What is the
Legal and other professional fees to process the patent application (useful life = legal life) Legal fees paid to successfully defending the device patent Acquisition of the competitive patent aimed for protecting old patent that shall increase company sales Acquisition of the related patent which extended the life of the patent for additional 2 years Legal fees paid to unsuccessful patents infringement suit against a competitor
930,000 535,500 609,000 981,562 375,000
correct cost of the patent upon initial recognition? carrying value of the patent on December 31, 2005? carrying value of the patent on December 31, 2009? carrying value of the patent on December 31, 2011? total cost from patent write off should be recognized in 2012?
PROBLEM 8 Madel Corporation’s patents had carrying value amounting to P840,000 as of December 31, 2012, before amortization. All patents were purchased on January 2, 2004, 6 years after their registration. Thus, these patents are being amortized over the remaining legal life from date of purchase. Legal expenses in successfully defending the patent totaling to P112,500 were debited to the account on January 2009. Amortization in 2009-2011 included amortization on the P112,500 for the remaining life of the relevant patent. It is determined that the P112,500 should have been expensed in 2009. It is further determined that one of the patents has a remaining life of only 3 years as at the beginning of 2012. This patent was originally assigned a cost of P315,000. REQUIRED: 1) What is the correct amortization of 2012? 2) What is the adjusted carrying value of the patents as of December 31, 2012? 3) What is the retroactive adjustment to the beginning retained earnings, if there are any, as a result of your audit?
PROBLEM 9 On April 1, 2012, Faye Corporation is contemplating to acquire all the issued and outstanding ordinary shares of Mona Inc. in a business combination accounted for as a purchase. The recorded assets and liabilities of Mona, Inc on April 1, 2012 follow:
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Cash Inventory Property and equipment, net of accum depr or P3,200,000 Intangible assets, including P500,000 goodwill Liabilities
P 800,000 2,400,000 3,500,000 1,300,000 (1,800,000)
The fair market value of the assets and liabilities of Mona Inc. on April 1, 2012 are as follows: Cash Inventory Property and equipment, net of accum depr or P3,200,000 Intangible assets, including P500,000 goodwill Liabilities
P 800,000 2,400,000 4,100,000 1,000,000 (1,800,000)
Records show that the company earned an accumulated net income of P4,650,000 from 2007-2011. The said accumulated profits included a gain on sale of fixed assets in 2010 and 2011 totaling to P1,000,000 and president’s annual bonus averaging to P150,000. Remaining life at the date of acquisition of PPE is 6 years and intangible assets have indefinite lives. The industry’s normal rate of return is 9%. REQUIRED: 1) Assuming that the company contemplates the acquisition price at P8,000,000, how much is the goodwill resulting from the resulting 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?
PROBLEM 10 On January 1, 2011, ABC Corporation acquired DEF Inc’s, net assets for a total of P10,000,000. DEF Inc. has manufacturing plants in three countries. The fair market values of the identifiable net assets of the operations from each country were as follows: Country X Country Y Country Z Rspaderes2013
P2,000,000 1,500,000 4,500,000 Page 5 of 11
At the beginning of 2012, a new government is elected in Country Z. It has promulgated a new legislation significantly restricting exports of ABC Corporation’s, main product. As a result, and for the forseeable future, ABC Corporation’s production in Country Z will be cut by 40%. On the same date, the carrying values of Country Zs net assets were as follows: Cash Receivables Inventories Property and equipment0 net Goodwill Payables
P 700,000 1,800,000 1,500,000 2,700,000 ? 700,000
Moreover, the company originally estimated annual future net cash flows from its operations in Country Z at P1,500,000. ABC uses the straight line method of depreciation over a 10-year life for the Country Z 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 Z cash-generating unit was 15%. REQUIRED: 1) How much is goodwill allocated to the cash generating unit Country Z upon acquisition? 2) How much is the value in use of cash generating unit Coutnry Z as of January 1, 2012? 3) How much from the total impairment loss should be recognized against goodwill of the cashgenerating unit Country Z? 4) What is the carrying value of the cash generating unit Company Z’s property and equipment after impairment loss recognition? 5) Assuming that inventories had fair value less cost to sell of P1,500,000, what is the carrying value of the property and equipment after impairment loss recognition?
PROBLEM 11 Vergile Corp. maintains the following items in its intangible account as of fiscal year ended June 30, 2012: Research (RED MICAH) Copyrights Goodwill
P98,475 94,500 48,000
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Audit findings: a) Research RED MICAH is for a research project which consists of the following charges: Salaries of research staff Patent acquired solely for the use of the project Special equipment acquired and useful for various similar research activities Patent acquired for use in several research projects including project (RED MICAH) Cost of pilot models Total
P27,750 18,000 15,000 24,300 13,425 P98,475
The patent has generally been found to be useful for approximately ten years while the special equipment useful for five years. You have further discovered both pantents 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 Copyright R23 Copyright B42
ACQUISITION DATE January 2, 2008 July 15, 2009
USEFUL LIFE 25 years 15 years
COST P45,000 49,500
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 business combination when it acquired the net assets of JM Corp. at an acquisition cost amounting to P2,373,000 on February 24, 2010. JM’s net assets were carried in its book at P2,325,000 while their fair value aggregated to P2,340,000. 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.
REQUIRED: 1) What is the carrying value as of June 30, 2012 of Project RED Micah, Patent, Copyrights and Goodwill 2) How much should be recognized as research expense for the fiscal year 2012? 3) How much is the amortization expense for the copyrights in fiscal year 2012? 4) How much is the amortization expense for the goodwill in fiscal year 2012?
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PROBLEM 12 Edward Corporation is engaged in developing computer software for small business at home computer market. 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, Edward Corp, has produced several products that have been very successful in the market place. The following costs were incurred during 2012: Salaries and wages of programmers during research Expenses related to projects prior to establishments of technological feasibility Cost of completing the detailed program design Cost of coding the product master after technical feasibility has been established Cost of testing the product master after technical feasibility has been established Amortization of capitalized software development cost from current and prior years Cost to produce and prepare software for sale
P660,000 470.400 750,000 141,000 156,000 160,500 337,800
Additional data for 2012: Sale of products for the year Beginning inventory Portion of goods available for sale sold during the year
P3,090,000 852,000 60%
REQUIRED: 1) What is the amount to be capitalized software development cost subject to amortization? 2) What is the cost of the ending inventory? 3) What is the total amount related to the development of computer software that should be expensed when incurred?
PROBLEM 13 Howard Corporation acquired a patent right on July 1, 2007 for P250,000. The remaining legal life on the date of purchase is 15 years. However, due to rapidly changing technology, management estimates that the remaining useful life on July 1, 2007 is only 5 years. At January 1, 2008, management is uncertain that the process can actually be made economically feasible and decides to write down the patent to and estimated recoverable amount of P75,000. Amortization will be taken over 3 years from the point. On January 1, 2010, having perfected the related production process, the entity adopts the revaluation mode to measure the patent. He patent now has a fair value of P300,000. Furthermore, the estimated remaining useful life is now believed to be 5 years. REQUIRED: 1) How much is the loss on impairment on January 1, 2008? 2) How much can be recognized as gain on impairment recovery in 2010? Rspaderes2013
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3) How much is the revaluation surplus as of January 1, 2010? 4) How much is the carrying amount of the patent on December 31, 2010?
PROBLEM 14 Elisa Corporation has its own research department. However, the Company purchases patents from time to time. The following is a summary of transactions involving patents now owned by the company: - During 2006 and 2007, Elisa spent a total of P459,00 in developing a new process that was patented (Patent X) on April 1, 2008; additional legal and other costs of P50,000 were incurred. - A patent (Patent Y) developed by Husein Dee, an inventory was purchased for P187,500 on December 1, 2009 on which date it had an estimated useful life of 12 and 1/2 years. - During 2008, 2009 and 2010, research and development activities cost P510,000. No additional patents resulted from these activities. - A patent infringement suit brought by the Company against a competitor because of the manufacture of articles infringing on Patent Y was successfully prosecuted at Acost of P42,600. A decision in the case was rendered in June 2010. - On June 1, 2011, Patent Z was purchased for P172,800. This patent had 16 years yet to run. - During 2012, Elisa expended P180,000 on patent development. However, the Company is still undecided as to how the patent, if approved by the Bureau of Patents, will generate probable future economic benefits. REQUIRED: 1) What is Patent X’s carrying value on December 31, 2012? 2) What is Patent Y’s carrying value on December 31, 2012? 3) What is Patent Z’s carrying value on December 31, 2012? 4) What is the total patent amortization expense to be reported on Elisa’s statement of comprehensive income for the year ended December 31, 2012? ] PROBLEM 15 ABC Corp., a computer software development and software distribution company, presented the following items among its noncurrent assets in its Statements of Financial Position as of December 31, 2010: Franchise Computer software Goodwill
P10,000,000 4,050,000 2,100,000
Your audit of the said items revealed the following information: Rspaderes2013
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a. The franchise agreement was between ABC and DEF Inc. which granted ABC the exclusive right to distribute the computer software products of DEF Inc. in certain areas of eastern and central Visayas for an indefinite period. The agreement was entered into early in January of 2007 and has required ABC corporation to pay DEF Inc. the total franchise fee amounting to P10M. 40% of the amount has been paid outright as down payment with the remaining balance payable in 5 equal installments starting the year after the agreement was completed. The prevailing market rate of interest for this type of transaction by the time the agreement was entered into was 11%. The company recorded the transaction as follows: 01/01/07
Franchise Cash Notes payable
10M 4M 6M
The Company charged the notes payable thereafter for the subsequent periodic payments. During the current year, verifiable evidence show that future net cash flows expected from franchise agreement with DEF may have been affected by the launching of DEF’s competitor for equally competitive products in the eastern and central visayas market. The company now estimates that its average net annual cash flows from distributing products of DEF amounting to P1.8M annually and will be cut by 40% because of this development. You have ascertained that the appropriate discount rate useful in the measuring impairment loss on the franchise is at 15%. b. The Company started developing computer software for small and medium business enterprises on January 1, 2009. The computer software account therefore, refers to the cost of computer application software developed internally by the company and distributes to small and medium business enterprises in eastern and central visayas. The carrying value of the software comprise of the following: Cost incurred in the research activities relating to the creation of computer software Costs incurred in completing the detailed program design Cost of computer facilities especially acquired for the coding and testing of product masters of the computer software (useful for many software development projects over 3 years) Operating system of the computer facility above Salaries of staff who worked on the coding and testing of the product masters Cost of supplicating the product master for sale
700,000 200,000 1,100,000 800,000
The Company was able to complete its first computer software for distribution by the end of 2009 and was able to sell the first batch of the products in 2010 generating P3M in product sales. The company estimates that the computer software shall be salable for about two more years at which time a better and more superior computer software with same capability may have been already created. The company further projects that it will generate approximately P1.5M more in product sale in 2011 and P500,000 in 2012. Rspaderes2013
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c. The Company’s Goodwill account comprise of the following expenditures: Preoperating expenses incurred in 2006 Massive advertising costs incurred in the early 2006 and 2007 to enhance the company’s image in the market (this increased potential for the company to generate sales in the future) Cost of building rapport and customer loyalty leading to very loyal customers who are committed to availing services of the company for an indefinite period of time Total
REQUIRED: 1) What is the correct carrying value of the Franchise as of December 31, 2010, before any impairment lsos, if there are any, is recognized? 2) What is the retroactive adjustment to the retained earnings, beginning as a result of your audit of the company’s franchise? 3) What is the impairment loss to be recognized against the franchise fee for the year ended December 31, 2010? 4) What is the adjustment to the retained earnings, beginning as a result of your audit of the company’s computer software? 5) What is the carrying value of the computer software account as of December 31, 2010? 6) How much from the items included as part of the company’s Goodwill can be recognized separately as intangible asset?
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