1. Define “intangible asset.

Intangible assets can not be physically touched but still hold value and can generate revenue.

2. Give three examples of intangible assets.

Trademarks, patents, copyrights, franchises and goodwill.

3. At what value are intangible assets typically reported?

The historical cost and the recorded cost at the time of acquisition determine the value of an intangible
asset. They do not depreciate like property and equipment assets do because no fair value can be
determined. All intangible assets except goodwill are amortized over the contractual life of the asset.

4. How does an intangible asset differ from property and equipment?

Tangible assets have a physical form and are used to generate income. Property and equipment are
used in the day to day operations of a firm.

5. What is amortization?

Amortization tie the asset's costs to the revenues it generates which extends the cost over the shorter
of the asset’s useful life

6. How does a company typically determine the useful life of an intangible?

Companies follow the International Accounting Standard guidelines and estimate based on historical
cost.

7. Under what circumstances could the cost to defend an intangible asset in court be capitalized to the
asset account?

Costs such as legal fees and other costs related to the successful defense of a patent, trademark or
copyright in court, registration or consulting fees for the intangible asset, trademark design costs and
any other direct cost incurred to obtain the asset can be capitalized.

8. Why are intangibles, like trademarks, not recorded at their market value, which can greatly exceed
historical cost?

Trademarks have an indefinite life

9. What are the two reasons intangible assets are reported at more than historical cost plus filing and
legal costs?

historical cost may have to be abandoned when applying the lower-of-cost-or-market rule to inventory
and also when testing for possible impairment losses of property and equipment. Those particular
departures from historical cost were justified because the asset had lost value.
10. When should a parent (acquiring) company record the intangibles of a subsidiary on its balance
sheet?

FASB has stated that a parent company must identify all intangibles held by a subsidiary on the date of
acquisition.

11. What is “goodwill”?

Goodwill arises when a company purchases another entire business. The value of the goodwill is the cost
to acquire the business minus the fair market value of the tangible assets, the intangible assets that can
be identified, and the liabilities that came with the business.

12. Is goodwill amortized like other intangibles?

No, goodwill is not amortized over time.

13. What should companies do with goodwill each reporting period?

Goodwill is checked periodically instead for impairment with a loss recognized if the value has
decreased.

14. Payments made over an extended period of time should be divided into what two items?

15. What is present value?

PV is the current value of a future sum of money or stream of cash flows given a specified rate of return.

16. What is an annuity?

A series of equal cash amounts at equal time intervals.

Multiple Choice
1. Which of the following would not be subject to amortization?

A. GOODWILL

2. Mitchell Inc. developed a product, spending $4,900,000 in research to do so. Mitchell applied for
and received a patent for the product in January, spending $34,800 in legal and filing fees. The patent
is valid for seventeen years. What would be the book value of the patent at the end of Year 1?

B. $34,800
3. Kremlin Company pays $2,900,000 for the common stock of Reticular Corporation. Reticular has
assets on the balance sheet with a book value of $1,500,000 and a fair value of $2,500,000. What is

goodwill in this purchase?

C. $400,000

4. What is the present value of receiving $4,800,000 at the end of six years assuming an interest rate
of 5 percent?

B. $6,432,459

5. Which of the following concerning the research and development costs is true?

A. ACCORDING TO U.S. GAAP, RESEARCH AND DEVELOPMENT COSTS MUST BE EXPENSED AS

6. Krypton Corporation offers Earth Company $800,000 for a patent held by Earth Company. The
patent is currently on Earth Company’s books in the amount of $14,000, the legal costs of registering
the patent in the first place. Krypton had appraisers examine the patent before making an offer to
purchase it, and the experts determined that it could be worth anywhere from $459,000 to
$1,090,000. If the purchase falls through, at what amount should Earth Company now report the
patent?

B. $14,000

7. What is the present value of receiving $15,000 per year for the next six years at an interest rate of 7
percent, assuming payments are made at the beginning of the period (annuity due)?

A. $76,503

CHAPTER 12

QUESTIONS

1. Give three reasons one company would purchase the stock of another.

Companies will use excess funds to buy ownership shares of other organizations to increase their own
profits. They are essentially investing their money in hopes of a return.

They may also purchase stock to gain influence within another organization. The third reason to buy
stock is to actually gain control of the company.
2. When is the purchase of stock in one company by another classified as a “trading security”?

If management’s intentions are to buy and sell the equity shares of another company in the near term,
the purchase is classified on the balance sheet as an investment in trading securities.

3. Where is dividend revenue reported?

The dividends declared and paid by a corporation will be reported as a use of cash in the financing
section of the statement of cash flows. Dividends are also reported on the statement of changes in
stockholders' equity. Dividends on common stock are not reported on the income statement since they
are not expenses.

4. At what value are trading securities reported on the balance sheet?

Market value

5. Why does the accounting for trading securities differ from that of other assets like buildings or
inventory?

When using the cost method of accounting for a dividend received the dividend revenue is reported as
part of other income on the income statement. The equity method the dividend received are classified
on the balance sheet as noncurrent

6. What is an unrealized gain or loss?

An unrealized gain is a profit from an investment that is in a profitable position but has not been sold
yet. An unrealized loss is when a company holds stock or an asset after it has decreased in price.

7. What is an available-for-sale security?

Available for sale securities are assets that can not be categorized as trading or held-to-maturity

8. At what value are available-for-sale securities reported on the balance sheet?

Fair Value

9. How does the accounting for unrealized gains and losses on available-for-sale securities differ from
trading securities?

The major difference between accounting for a portfolio of trading securities and a portfolio of
available-for-sale securities is with trading securities gains on losses generated on these securities are
recorded under cash from operating activities hence it is used in calculating the operating profit / loss
for the firm. Whereas available-for-sale securities gains and losses on these securities are charged
against shareholder's equity and recorded under other income.
10. Define “comprehensive income.”

Comprehensive income is defined by the Financial Accounting Standards Board, or FASB as “the change
in equity [net assets] of a business enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners.”

11. Which method of accounting is used when one company owns enough stock in another to exert
“significant influence”?

Equity Method

12. When trying to determine if the equity method of accounting should be used, what guidelines are
available to help accountants?

US GAAP Guidelines

13. When and how is income from an equity investment recognized by the owner?

ability to exercise significant influence determines if income from an equity investment is recognized.

14. How are dividends paid by an investee reported by the owner under the equity method?

When applying the equity method, the investor does not wait until dividends are received to recognize
profit from its investment. The investor reports income as it is earned by the investee.

15. How much stock must one company own to be considered “in control” of another?

More than 50%

16. Define “consolidation.”

When the individual account balances for a subsidiary is combined with its parent company on one
financial statement.

17. How is total asset turnover calculated?

Asset turnover ratio = net sales/average total assets

18. How is return on assets determined?

Return on assets ratio = net income/average total assets

1. On March 5, Maxwell Corporation purchased seventy shares of Tyrone Company for $30 per share,
planning to hold the investment for a short time. On June 30, Maxwell prepares its quarterly financial
statements. On that date, Tyrone is selling for $32 per share. What is the unrealized gain Maxwell will
report and where should it be reported?

a. $140 unrealized gain, owners’ equity section of balance sheet

b. $140 unrealized gain, income statement

c. $2,240 unrealized gain, income statement

d. $2,100 unrealized gain, owners’ equity section of balance sheet

2. Which of the following is not a reason investments in trading securities are shown at their fair value
on the balance sheet?

d. Fair value is easier to determine than historical cost

3. Jackson Corporation purchased 150 shares of Riley Corporation for $46 per share. The investment is
available for sale. On 12/31/X5, Riley’s stock is selling for $43 per share. Jackson’s net income for the
year was $235,000. What was Jackson’s comprehensive income?

a. $235,000

b. $228,100

c. $234,550

d. $228,550

4. Anton Company owns 45 percent of Charlotte Corporation and exerts significant influence over it.

This investment should be shown as:

a. An equity method investment

b. An available-for-sale investment

c. A consolidation

d. An investment in trading securities

5. Tried Company began the year with $450,000 in total assets and ended the year with $530,000 in
total assets. Sales for the year were $560,000 and net income for the year was $46,000. What was Tried
Company’s return on assets for the year?
a. 114%

b. 9.4%

c. 10.2%

d. 8.2%

6. Hydro Company and Aqua Corporation are in the same industry. During 20X9, Hydro had average
total assets of $35,000 and sales of $47,800. Aqua had average total assets of $49,000 and sales of

$56,900. Which of the following is true?

a. Aqua Corporation has a total asset turnover of 1.37 times.

b. Hydro Company is not using is its assets as efficiently as Aqua Corporation.

c. Aqua Corporation has a higher ROA than Hydro Company.

d. Hydro Corporation has a total asset turnover of 1.37 times.

7. Lancaster Inc. purchases all the outstanding stock of Lucy Company for $4,500,000. The net assets of
Lucy have a fair value of $2,900,000, including a patent with a book value of $4,700 and a fair value of
$159,000. At what amount should the patent and any goodwill from this purchase be shown on
consolidated financial statements on the date of purchase?

a. Patent—$4,700, Goodwill—$0

b. Patent—$159,000, Goodwill—$2,900,000

c. Patent—$159,000, Goodwill—$1,600,000

d. Patent—$4,700, Goodwill—$4,500,000

8. On 12/31/X2, Brenda Corporation purchased Kyle Inc. for $3,400,000. Kyle had one asset, a
trademark, whose fair value ($45,000) exceeded its book value ($15,000) by $30,000. The trademark has
a remaining useful life of five years. Goodwill was also recorded in this purchase in the amount of
$146,000. Kyle continued to operate after the purchase, and now on 12/31/X3, Brenda is preparing
consolidated statements for the year. Independent appraisers now believe Kyle’s trademark is worth

$50,000. Brenda’s independent auditors believe that the goodwill has been impaired slightly and is now
worth $120,000. At what amounts should the trademark and goodwill be shown on Brenda’s
consolidated balance sheet on 12/31/X3?

a. Trademark—$36,000, Goodwill—$120,000

b. Trademark—$30,000, Goodwill—$146,000
c. Trademark—$50,000, Goodwill—$120,000

d. Trademark—$50,000, Goodwill—$146,000