Chapter12 - Answer PDF
Chapter12 - Answer PDF
Chapter12 - Answer PDF
SUBSTANTIVE TESTS OF
12 INTANGIBLE ASSETS
12-2. Research and Development Costs vary widely among companies. Many
expenditures do have future worth, while others are so highly uncertain as to
future value that recording them as assets is clearly improper.
The auditors interest in auditing Research and Development costs stems from the
objective of determining whether they should be deferred or charged against
current operations. He shall be guided by GAAP in judging whether the clients
treatment of the Research and Development Costs is justified or not.
The rapid amortization of the leasehold for the first twelve (12) years resulted to
an understatement of income totaling to P60,000:
Correct amortization P450,000 x 12 P270,000
20
Amortization per client (P27,500 x 12) 330,000
Over-amortization P 60,000
In view of the above, the amount of P60,000 should be added back to Retained
Earnings as correction of prior years profits. Furthermore, amortization of
P22,500 for the 13th year should be recorded.
These adjustments would result to a net increase in the Retained Earnings balance
which will enable the company to declare dividends without depleting the
Retained Earnings balance significantly.
12-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (b)
If the original lease had contained a renewal clause for an additional 20 years, the
depreciation rate would still be 5%, which is based on the original term of the
lease. The renewal of the lease contract is not certain and therefore will not be
considered in the determination of the amortization period.
Cost as
Description Recorded Amortization Per Client
1997 1998 to 2005 Total Adjustment As Adjusted
Patent P P 40,000 P1,212.12 P 19,393.94 P 20,606.06 P(5,151.52) P 15,454.54
Q 120,000 3,529.41 56,470.59 60,000.00 (15,000) 45,000.00
R 160,000 4,705.88 75,294.12 80,000.00 (20,000) 60,000.00
P320,000 P9,447.41 P151,158.65 P160,606.06
Less: Adjustment
as per BIR
requirement 80,000 (2,361.85) (37,789.67) (40,151.52)
As Adjusted P240,000 P7,085.56 P113,368.98 P120,454.54 P120,454.54
(a) (b)
210,000
Q&R = x 0.5 = 6,176.47
17 P7,085.56
210,000
Q&R = x 0.5 = 98,823.53
17 P113,368.98
Substantive Tests of Intangible Assets 12-3
Adjusting Journal Entries
(1) Capital in excess of par value 80,000.00
Patent P 10,000.00
Patent Q 30,000.00
Patent R 40,000.00
To adjust patent valuation to conform
to BIR requirement.
(2) Accumulated amortization Patent P 5,151.52
Accumulated amortization Patent Q 15,000.00
Accumulated amortization Patent R 20,000.00
Retained earnings Correction of prior
years profit 40,151.52
To adjust amortization provision from
1997 to 2005.
Note to Instructor: For ease of discussion, the adjusting entries in the solution are
dated to correspond with the original erroneous journal entries. In actual practice,
they would be dated as of the year-end.
Calculation of Goodwill
Supporting Computations:
Requirement (a)
Allocation of the P137,500 cost to the individual assets in the group of assets
acquired is based on the relative fair value of the individual assets.
12-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Journal entries for 2004, 2005 and 2006, relative to intangible assets, are as
follows:
2004
2005
2006
Computations
Amortization for 2006:
Patent A: (P27,192 / 5 years) (6 / 12) P 2,719
Patent B: (P36,256 / 12 years) (6 / 12) 1,511
P 4,230
The cost basis of patent B is P36,256 - P1,511 + P8,800 - P3,546). 2005, a full
years amortization is taken by dividing the unamortized cost by the remaining
useful life. In 2006 this is P39,999/10 years or P3,809.
Requirement (b)
The legal costs of a court defense should be charged to expense whether the suit is
won or lost because it does not meet the recognition criteria. Also, the
unsuccessful defense implies that Patent A is of no further value to the company
and leads to the write-off of the remaining unamortized cost of that patent.
12-8 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (a)
Patents
1. Balance before adjustment, 12/31/06 P550,000
Correction: Deduct unamortized balance of P75,000
expenditures incorrectly debited to account on 1/1/03:
P75,000 x (7 years/10 years) (52,500) [AJE (1)]
Corrected balance before 2006 amortization P497,500
2. 2006 Amortization
Patent having two years remaining life
Unamortized cost: P210,000 x (7 years/14 years)
= P105,000
Franchise Agreement
1. Balance before adjustment, 12/31/06 P 95,000
Correction: Deduct periodic payment charged to account (45,000) [AJE (3)]
Corrected balance before 2006 amortization P 50,000
2. 2006 Amortization:
P50,000 / 5 years P 10,000 [AJE (4)]
Organization Costs
1. Balance before adjustment, 12/31/06 P102,000
Correction: Legal fees incorrectly charged to
Goodwill account in 1998 P45,000 [AJE (5)]
Amortization of above costs,
1998 - 2004 (P45,000 / 40) (7 years) 7,875 37,125 [AJE (6)]
P139,125 [AJE (7)]
Patents
AJE (1) Retained Earnings 52,500
Patents 52,500
Franchise Agreement
AJE (3) Selling and Administrative -
Franchise Expense 45,000
Franchise Agreement 45,000
Organization Cost
AJE (5) Organization Costs 45,000
Goodwill 45,000
Goodwill
AJE (8) Selling and Administrative
Advertising Expense 100,000
Goodwill 100,000
Requirement (b)
Summary:
Requirement (a)
The deficiencies listed below are apparent from the balance sheet and the
explanations given. The assumption is made that costs incurred have been
properly classified by Mr. Balagtas. The correct treatment of each item is
presented in the column on the right.
Requirement (b)
Requirement (a)
Requirement (b)
When a price is paid for a group of assets, the total price must be allocated to the
individual assets. Because we know neither the total fair value of the tangible and
other intangible assets acquired from Rain Company nor the price to be paid by
the Nikko Corporation, we cannot determine whether Nikko Corporation has any
goodwill to record. The total price to be paid by the Nikko Corporation is
indefinite but it may be estimated by discounting the expected receipts (1% of net
sales) at the end of each of the next 5 years and adding the initial P450,000 cash
payment. If the estimated purchase price exceeds the sum of the estimated fair
values of the tangible and other assets purchased, then the excess may be recorded
as goodwill.
Interest on mortgage bonds: An amount equal to the interest cost incurred in 2004
(P60,000) is clearly a cost that can be associated with the normal construction
period and can be regarded as a normal element of the capitalized cost of the
physical assets of the shopping center because the construction period would have
ended at the end of the year if the typhoon had not occurred. 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 and 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
Substantive Tests of Intangible Assets 12-13
building the center and preparing it for occupancy, including interest during the
construction period.
The extension of the construction period to October 2005 because of the typhoon
was externally imposed and so the interest capitalization period continues until
final construction is complete. That is, the additional interest cost is capitalized
and not expensed as a loss from the typhoon.
Cost of obtaining tenants: Both the 2004 and 2005 costs of obtaining tenants
should be capitalized and amortized over the life of the leases. The fact that all of
the tenants who were signed when the typhoon occurred accepted the October
occupancy date indicates that the total cost of obtaining tenants was not affected
by the delay.
The cost of obtaining tenants has a direct and easily identifiable relationship to the
rental income to be earned over the terms of the leases. Under these
circumstances, the problem of reliably measuring periodic net income is best
solved by matching costs with the revenues to which they are directly related.
The initial expense treatment of the 2004 advertising cost is appropriate because it
is a start-up cost.
The 2005 advertising cost may also be considered as a start-up cost or simply
expensed as advertising cost incurred.
12-14 Solutions Manual to Accompany Applied Auditing, 2006 Edition
12-14. Lee Manufacturing Corporation
Lee Manufacturing Corporation
Financial Statement Worksheet
For the Year Ended December 31, 2006
Trial Balance Adjustments Income Statement Balance Sheet
General Ledger Accounts Debit Credit Debit Credit Debit Credit Debit Credit
Cash P 61,000 P 61,000
Accounts receivable 92,500 (8) P 2,500 95,000
Allowance for doubtful accounts P 500 (500)
Inventories 38,500 38,500
Machinery 75,000 (1) 17,000 92,000
Equipment 29,000 (8) 8,500 37,500
Accumulated depreciation 10,000 (10,000)
Patents 85,000 (1) P 17,000 68,000
Leasehold improvements 26,000 (8) 11,000 15,000
Prepaid expenses 10,500 10,500
Organization costs 29,000 (9) 29,000
Goodwill 24,000 (7) 24,000
Licensing agreement no. 1 50,000 (4) 1,250 19,500
(5) 29,250
Licensing agreement no. 2 49,000 (3) 1,000 50,000
Accounts payable 147,500 P 147,500
Unearned revenue 12,500 (3) 1,000 13,500
Capital stock 300,000 300,000
Retained earnings, Jan. 1, 2006 27,000 (27,000)
Sales 768,500 P 768,500
Cost of goods sold 454,000 (2) 3,400 P 464,400
(6) 5,500
(10) 1,500
Selling and general expenses 173,000 (7) 8,000 181,000
Start-up expenses (7) 16,000 45,000
(9) 29,000
Interest expense 3,500 3,500
Extraordinary losses 12,000 12,000
Accumulated amortization:
patents (2) 3,400 (3,400)
Accumulated amortization:
leasehold improvements (10) 3,000 (3,000)
Accumulated amortization:
licensing agreements (6) 5,500 (5,500)
Prior period adjustment (4) 1,250 (30,500) *
licensing agreement no. 1 (5) 29,250
Prior period adjustment
amortization of leasehold
improvements (10) 1,500 (1,500) *
Net income for 2006 62,600 62,600
Totals P1,239,000 P1,239,000 P124,400 P124,400 P 768,500 P 768,500 P 470,600 P 470,600
* Generally, adjustments in the current period that could have been determined by management in a prior period should enter into the determination of net income in the current
period. However, because the 2006 financial statements were not prepared in conformity with generally accepted accounting principles, these retroactive adjustments are
considered to be errors and treated as prior period adjustments and, therefore, should be applied against beginning retained earnings.
Substantive Tests of Intangible Assets 12-15
12-14. Lee Manufacturing Corporation (continued . . . )
Requirement (1)
Broadway Corporation
Intangibles Section of Balance Sheet
December 31, 2006
Schedule 1:
Schedule 2:
Computation of Patent
Schedule 3:
Computation of Trademark
Accumulated
Cost Amortization
Cost of trademark at July 1, 2003 P40,000
Amortization through December 31, 2006
(P40,000 20 years = P2,000 x 3 years) P7,000
Balance, December 31, 2006 P40,000 P7,000
Deduct accumulated amortization (7,000)
Trademark balance, December 31, 2006 P33,000
Requirement (2)
Broadway Corporation
Expenses Resulting from Intangibles Transactions
For the Year Ended December 31, 2006
The fair value is considered the recoverable amount. The estimated total
future flows from the trade name of P16,000 need to be discounted and the
resulting present value would in most probability be a lower amount than
P15,000.
Requirement (b)
Organization Expense ................................................................ 23,000
Cash (Payables)................................................................ 23,000
Requirement (a)
Jo Tan Company
INTANGIBLES SECTION OF BALANCE SHEET
December 31, 2007
Patent from Francis Argante Company, net of accumulated
amortization of P560,000 (Schedule 1) P1,440,000
Franchise from JC Company, net of accumulated
amortization of P48,000 (Schedule 2) 432,000
Total intangibles P1,872,000
12-20 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (b)
Jo Tan Company
Income Statement Effect
For the year ended December 31, 2007
Patent from Francis Argante Company:
Amortization of patent for 2007
(P1,800,000 5 years) P360,000
Franchise from JC Company:
Amortization of franchise for 2007
(P480,000 10) P 48,000
Payment to Reagan Company
(P2,500,000 X 5%) 125,000 173,000
Research and development costs 433,000
Total charged against income P966,000
Requirement (a)
Patent X
Life in years 17
Life in months (12 X 17) 204
Amortization per month P150
Number of months amortized to date
Year Month
2004 10
2005 12
2006 12
2007 12
46
Patent Z
Life in years 4
Life in months (12 X 4) 48
Amortization per month P300
Number of months amortized to date
Year Month
2006 4
2007 12
16
Book value 12/31/07 P9,600: (P14,400 [P300 X 16])
Requirement (b)
2. The book value of Patent Y is P11,250 and its estimated future cash flows are
P6,000: (3 X P2,000) therefore Patent Y is impaired. The impairment
loss is imputed as follows:
Patent AA amortization
Life in years 9 1/2
Life in months 114
Amortization per month P320
P320 X 6 = P1,920
Requirement (a)
Cash................................................................................................
50,000
Receivables................................................................................................
90,000
Inventory ................................................................................................
125,000
Land................................................................................................
60,000
Buildings ................................................................................................
75,000
Equipment ................................................................................................
70,000
Trademarks................................................................................................
15,000
Goodwill................................................................................................
65,000
Accounts Payable ................................................................ 200,000
Notes Payable ................................................................ 100,000
Cash................................................................................................ 250,000
Note that the building and equipment would be recorded at the 7/1/06 cost to
Brigham; accumulated depreciation accounts would not be recorded.
Substantive Tests of Intangible Assets 12-23
Requirement (b)
Requirement (a)
Requirement (b)
Fair Value
Historical Cost Fair Value 12.31.07
CV 12.31.06 P4,300,000 P3,200,000
Amortization, 2007 430,000 320,000
CV 12.31.07 P3,870,000 P2,880,000 P3,400,000
Recovery 520,000
Requirement (c)
Copyrights................................................................................................
520,000
Copyright Amortization Expense
or Gain on Recovery of Previously
Recognized Impairment ................................ 520,000
12-24 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Franchises................................................................................................
42,000
Prepaid Rent................................................................................................
28,000
Retained Earnings (Organization Costs of P6,000 in
2006) ................................................................................................
6,000
Retained Earnings (P16,000 P6,000) ................................ 10,000
Patents ................................................................................................
74,000
Legal fees ................................................................................................
12,650
Research and Development Expense ................................................................
(P75,000 + P160,000) ................................................................ 235,000
Goodwill................................................................................................
278,400
Intangible Assets................................................................ 686,050
Requirement (a)
All costs incurred prior to January 1999 are related to research and development
activities and were expensed as incurred.
Substantive Tests of Intangible Assets 12-25
Requirement (b)
The costs incurred in 2000 and 2002 are related to research and development
activities and are expensed as incurred. Legal fees in successful defense of the
patent in 2001 could be capitalized and considered GAAP.
Requirement (c)
The legal costs in 2006 were expensed because the suit was unsuccessful. Even if
the lawsuit was successful, the legal fees would be likewise charged to expense.
This is in accordance with PAS 38, Intangibles which was made effective in 2004.