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“And welcome to the session. This is professor farhad and session in this session. We we would look at intangible assets. So we re going to define intangible asset and at their characteristics.
So what are intangible assets. The first thing you want to think of at the angela bassett is something that lack physical existence. It doesn t have a physical substance so because assets usually. When you think of an said to me think of equipment building land cash money in the bank.
Those are physical asset those are physical assets or just anja ballasts intangible assets. One of their characteristics is they lack physical existence that don t have that physical presence that you can touch them and the other thing is they are not financial instrument. They are not stocks or bonds that they are considered financial instrument okay the most common type of intangibles the most common type of intangibles are patent copyright franchises or licensing fee trademark or trade name like coca cola coca cola as a trademark and they ve been around for decades goodwill will cover this will cover this intangible in details later on i will cover the other ones as well and details. But goodwill.
We re going to be spending more time on goodwill down the road. So how do we value intangible. So what happened when we initially purchase the intangibles well intangible as an asset so how do we record our assets. We record our assets when we when we acquire the asset we record them at cost just like any other asset.
What do we include we include all necessary cost to make the intangible ready for its intended use basically like any other asset. Because it s an answer and it the historical principle will apply the historical cost principle will apply the cost principle will apply to this asset. You purchase the asset at at how much it costs you okay now it happened. If you purchase the answer via stocks or via something else.
Well you would look at which of the two assets you would know the fair market value. If you know the asset that you are exchanging. If you know your fair market value of the stock. Then you use the fair market value of the stock that you are trading.
If you don t know if you don t know your fair market value you d use the fair market value of the other 40. But usually usually you would know the fair market value of your assets. Usually that s that s the case. But the rule is whichever fair market value is more clear clearly evident so costs typically include basically the the biggest.
One units. The purchase price any legal fees and any other incidental expenses that are related to acquiring this asset. Gets. Included now we need to talk about entered internal ii.
Created intangibles. Because two ways you can have intangibles you can purchase them from another party or you can create them internally. So and the way you treat those two are the way you treat them for accounting purposes. Or the thing generally speaking okay internally.
Created intangibles are expensive. So basically if a pharmaceutical company is researching a drug well that s rnd let s give rnd out. But it when qooco let s assume coca cola when they created the secret formula for the drink okay that s an intangible. But that s an intangible created internally so the cost to create that intangible is the secret formula for that drink is expensed.
Only capitalized direct cost incurred and development once once you have a valuable viable product and now you develop the product. If that cost development cost is capitalized okay. Such also as legal costs as well once you have a product that s there is a that is useful for someone you re starting to produce in it what do you want to do you want to register that with the what the government s you re going to incur legal cost. But as you are incurring cost to test the answer that you are testing.
The secret formula. The drug that you are testing all these costs rnd is expensed. Only once the product becomes viable. And you are developing the product intangible.
Any any cost gets capitalized. It means we don t expense you put it on the app on the balance sheet and we will eventually expense it through amortization an interesting example is google google expense the rnd cost incurred to develop its valuable search engine so google they have a great product at search engine the best one in the whole world. But as they were developing the search engine. They expense the they expense the expenditure of the expense the cost because when they were development the when they were developing the search engine.
They did not know if at the end of the day. They re going to have a viable product or not okay. So think about a pharmaceutical company when they start to research. A drug about the cancer well at the beginning.
They if they know for sure that at the end of the day they re going to have a problem that they can sell they re going to have an asset from this research and development then they will capitalize their cost. But at the beginning. They really don t know they may spend millions and millions of dollars and those millions of dollars would give them zero benefit in the future and the definition of an asset. That s going to provide you some benefit in the future.
So you don t capitalize you don t treat the expenses as expenditure as asset until you have a viable. A viable product. Okay so that s why the idea of internally created intangibles you expense them until the development stage. It means now you have a buy something viable.
Some type of product that s viable. Okay and we have to differentiate between limited life intangibles and unlimited life intangibles. What do we mean by limited life intangibles. It means they have a limited life.
We can assign a life to these product. You can assign the life okay. Why is that important because if we can assign allies. Then we can amortize by a systematic charge to expense over it s useful life.
But if there is no light for an answer if we cannot assign a life for an asset and here we are discussing intangible answer can you amitai something with no life you cannot. Because the point of amortization is over a period of time over the useful life of the asset usually you will credit asset or accumulated amortization so you re going to either you re going to debit amortization expense credit either the asset for a contra account called accumulated that deep amortization the useful life should reflect the period over which the answer will continue to cash flow. The useful life of the asset should reflect it doesn t you know you re not going to be 100 accurate because conditions and economic conditions as well as market conditions will always change. But the useful life should reflect the period that watch the asset will contribute cash because as it is contributing cash you want to match the expenses.
You want to match the expenses with the cash flow. Which is revenues and expenses amortization should be cost loss any residual values. When you calculate amortization if there s any residual value dislike with a tangible asset. You will deduct the residual value companies should evaluate limited life intangibles now those intangibles.
Whether they have to have a limited life for i m sorry a limited life for impairment. So they are subject to impairment those limited life intangibles. It doesn t mean once you amortize them we don t look back and see if they are useless. If they became useless or if they lost some lost their value a permanent loss of their value we test them for impairment.
Okay. So limited life they are tested for impairment because you re going to see unlimited life they will be tested. But limited life asset intangible assets will also be tested for impairment. So what about indefinite life inventions.
Basically. They don t have a definite life and we re going to look at some examples like the trademark that coca cola has it has an indefinite life on coca cola existed. As early as the late the early nineteen hundred late eighteen hundreds and the trademark. It has an indefinite life okay so there s no foreseeable limit on time.
The asset is expected to provide cash flow. So up since that time cocco lab. It did at the trademart for coca cola is providing cash flow for the business. So that s an indefinite life intangible.
You must test indefinite life intangible for impairment at least annually. Now how since you don t advertise it since you don t amortize it since you don t spare at the expense. You don t know amortization. What do you have to do with humble indefinite life intangibles you have to test at least annually.
You have to check is this intangible asset that i have is it still viable is it still is it still a generating cash flow for me enough cash flow to cover. It s expected value so for an indefinite we test at least once annually. And basically this is a summary type of intangibles the limited life ones if we purchase them notice manner of acquisition. If we purchase them obviously we will capitalize it because how much do we capitalize the cost if they are internally generated.
We expense them expense them except for direct cost such as legal costs well once you want to file the paperwork. The legal cost is is capitalized now what do we do with them. We if they have limited life. We amortize them over their useful life after we buy them we amortize them over their useful life and we also test them for impairment so simply put there they are treated as any other as any other to a great degree and as any other answer they get capitalized amortized of their useful life tested for impairment using the two step approach that we learn in the previous chapter indefinite life asset indefinite life adventure bowles.
If they are if they are purchased. We capitalize. If they are internally generated. Generally speaking will expense until the development the stage.
We do not amortize because why because they have no no definite life no definite life. So over how many years were going to advertise them we don t know we do test them for impairment. But their test for impairment is a little bit different. It s called the fair value test.
Only so it s clearly one step. One step process and we would look at an example later on this is basically a summary of the characteristics of intangibles and we have six major types of intangibles organ look at the six major type. We have marketing related customer related artistic related contract related technology related and good world and marketing related. The intangible asset.
Examples. Some examples trademark or trade. Name. Coca cola.
Newspaper masthead internet domain. Names and non competition. Agreement. Basically the domain name for example.
The pats calm or google. I mean google. It s worth more than just the internet domain names. But any internet domain names.
It has value tell family in the united states trademark or trade names have legal protection for indefinite number of years indefinite number of 10 years or renew up 10 year renewal period. So every ten years you have to renew it and the expectation is that you have a trade what you re going to renew it so it will have indefinite life so as long as you renew it as long as the corporation coca cola keeps renewing the trade name and the trademark then no one can use it so technically. It s endeavour you capitalize acquisition cost and no amortization. What do you do we test those intangibles on a yearly basis customer related intangibles those are different type of intangible examples will be customers with us assume you bought a customer list from a company for you you bought data about clients for your own purpose.
That s an intangible video. You paid money to obtain that list now you have a list of customers that you re going to be contacting. Those are leads that might provide you future benefit. So it s an intangible overall production.
Backlogs or and both contractual and non contractual. Customer relationship. Capitalized acquisition cost and amortized to expense over its use for life. So any many people look if there s any other example about customer related maybe we can look at them look at different examples actually we do have an example right here on the next slide.
So let s work this example for a marketing related intangible. A customer related intangible. So breen market requires the customer list of a large newspaper for six million dollar on january 1st. 2014.
So they obtain the customer list and they they paid six million dollar well obviously this will be their cost to acquire the intangible asset. Because the list of names. It has note. There s no physical value for there s an intangible value for greenmarket.
Expect the benefit from the information evenly over the over a three year period. So they expect to be contacting those the list of these of those customers and the next three years even record. The purchase list and the amortization of the customer list at the end of each year. So when we buy the asset.
What s the what s the rule well the general rule is you purchase the asset at cost you recorded at historical cost. Which is six million now. What s going to happen you are going to expense the cost good going to amortize anymore specifically going to be advertising. The cost over the next three years so every year you will debit amortization expense two million credit customer lists or you can also credit accumulated amortization so sometimes some companies use accumulated amortization or you could just credit.
The answer directly. Which is customer bus hour fistic related intangibles examples are plays in the trivia t. Works musical works pictures for the grabs and video and other visual material copyright granted for the life of the creator plus seventy years this is those are the copyright. The copyright that i rented capitalized cost of acquiring the asset.
If you re acquiring the answer and defending now with defending is defending means you are defending the asset. The heir defending the asset against someone so a few moves well it means your intangible is no longer useful so you want to make sure that you only paralyse. The successful defense if you lost a few something if somebody infringe on your asset. And you try to defend it that that asset and you lost well if you lost that means that intangible is not really an intangible it lost value therefore you have to test for impairment and your defense cannot be capitalized.
It has to be expense. So you only capitalize any successful defense and you amortize to expense over the useful life those are artistic related intangible assets. The walt disney company in the mickey mouse contract related intangibles examples are franchise licensing agreement construction permit broadcast right and service or supply contract. Okay basically a franchise is a license with with a limited life ok and should be amortized to expense over the life of the french and basically the operator subway or to open a mcdonald you need to pay a fee to use the to use their name so that s basically it s considered a franchise.
So when you pay your gonna obviously capitalize the cost and what are you going to do you re going to amortize the expense franchise with an indefinite life should be carried at cost and not amortize. So. If you have a franchise. And it does it has unlimited life well then that s different once it has unlimited life.
Then you don t have to worry about immobilization. What do you have to worry about you have to worry about impairment on a yearly basis okay so basically the franchise gives you the right to sell your product or services or use your trademark. So that s an important answer. Because if you have if you open a mcdonald s you don t have to do any marketing.
Because everybody know that any mcdonald s so people are more likely to stop by and by your place a business or if you have a subway or if you have a marriott. So you don t have to worry about marketing. Because that value was already created and you re paying for that value to operate a business technology. Technology.
Related intangibles. It relate to basically innovation and technological advances. Example will be patented technology and trade secret. Granted by us patent and trademark office.
So what will be what will be a good example. It s basically you invented a a website or a software and you want to and you want to make sure no one s going to copy it and reproduce. It okay so basically you have to protect your answer. Okay so that the pattern gives the holder exclusive right to use manufacture and sell okay.
So it gives you that right to manufacture use and sell the product over a period of 20 years and usually usually this is for pharmaceutical companies. They re very concerned about this because after 20 years. What happened you have you have imitators or companies. That s going to generate that s going to produce the product.
A generic type a generic a generic drug that s going to compete with them. So the government said well guess what we re going to give you a production for 20 years to recoup your cost so it gives the holder of the patent. The 20 years to recoup their cost. And what you do you capitalize the cost if you purchase a patent or if you do purchase a patent while you capitalize the cost however remember if you if you internally generated expense any rnd okay expense any rnd cost and developing a patent.
You expense. The r. D. Cost.
Then you amortize over the legal or use for life. Whichever is shorter. When you amortize you would amortize over the legal or useful. Life let s take a look at this example.
Haircut. Co anchored. 180000. And legal costs on january 1st to successfully defend its patent.
So so the key is they successfully defended the patent. The patent used for life is 20 years amortized on a straight line basis. So how would they record this successful defense well if this if the defense was successful they are going. To debit the asset itself patent.
180000 credit. Cash 180000. Now we re going to go ahead. And amortize.
This over the next. 20 years. So amortization expenses. 9000 patent.
Or a team that amortize accumulated amortization is 9000. So. This is an example of successfully defended a patent. Which is which will allow you to capitalize it if the patent was not successfully defended this will be an expense.
Some type of a legal expense and now that s going to give arise to be intangible itself to your patent and now you need the test for impairment to see if you and if your intangible has any value or if it lost value and you have to test for impairment so that s interesting when it comes to legal defense. The next intangible we look at is goodwill. But i would like to have a separate recording for goodwill because it requires a little bit more calculations so at this point. All what we did is basically went over some correct characteristic of intangibles and we look at certain type of intangibles obviously you want to make sure you read the book.
But this is an overall idea. The next topic. We would look at is the goodwill what is goodwill and how do we treat goodwill for accounting purposes. Obviously if you have any questions by all means see me ” .
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