Homework Week 1

E12-1

(Classification Issues—Intangibles) Presented below is a list of items that could be

included in the intangible assets section of the balance sheet.
1. Investment in a subsidiary company.
2. Timberland.
3. Cost of engineering activity required to advance the design of a product to the
manufacturing stage.
4. Lease prepayment (6 months’ rent paid in advance).
5. Cost of equipment obtained.
6. Cost of searching for applications of new research findings.
7. Costs incurred in the formation of a corporation.
8. Operating losses incurred in the start-up of a business.
9. Training costs incurred in start-up of new operation.
10. Purchase cost of a franchise.
11. Goodwill generated internally.
12. Cost of testing in search for product alternatives.
13. Goodwill acquired in the purchase of a business.
14. Cost of developing a patent.
15. Cost of purchasing a patent from an inventor.
16. Legal costs incurred in securing a patent.
17. Unrecovered costs of a successful legal suit to protect the patent.
18. Cost of conceptual formulation of possible product alternatives.
19. Cost of purchasing a copyright.
20. Research and development costs.
21. Long-term receivables.
22. Cost of developing a trademark.
23. Cost of purchasing a trademark.

Instructions
(a) Indicate which items on the list above would generally be reported as intangible
assets in the balance sheet.
10, 13, 15, 16, 17, 19, 23
(b) Indicate how, if at all, the items not reportable as intangible assets would be
reported in the financial statements.
1. Long-term investments in the balance sheet
2. Property, plant, and equipment in the balance sheet.
3. Research and development expense in the income statement.
4. Current asset (prepaid rent) in the balance sheet.
5. Property, plant, and equipment in the balance sheet.
6. Research and development expense in the income statement.
7. Charge as expense in the income statement.
8. Operating losses in the income statement.
9. Charge as expense in the income statement.
11. Not recorded; any costs related to creating goodwill incurred internally
must be expensed.
12. Research and development expense in the income statement.
14. Research and development expense in the income statement.
18. Research and development expense in the income statement.
20. Research and development expense in the income statement.
21. Long-term investments, or other assets, in the balance sheet.
22. Expensed in the income statement.
E12-4

(Intangible Amortization) Presented below is selected information for Palmiero

Company.

1. Palmiero purchased a patent from Vania Co. for $1,500,000 on January 1, 2010.
The patent is being amortized over its remaining legal life of 10 years, expiring on
January 1, 2020. During 2012, Palmiero determined that the economic benefits of
the patent would not last longer than 6 years from the date of acquisition. What
amount should be reported in the balance sheet for the patent, net of accumulated
amortization, at December 31, 2012?

Palmiero should report the patent at $900,000 (net of $600,000 accumulated

amortization) on the balance sheet. The accumulated amortization should be
calculated as follows.
Amortization for 2010 and 2011 ($1,500,000/10) X 2........... $300,000
2012 amortization: ($1,500,000 – $300,000) ÷ (6 – 2)..............300,000
Accumulated amortization, 12/31/12........................................$600,000

2. Palmiero bought a franchise from Dougherty Co. on January 1, 2011, for

$350,000. The carrying amount of the franchise on Dougherty’s books on January
1, 2011, was $500,000. The franchise agreement had an estimated useful life of
30 years. Because Palmiero must enter a competitive bidding at the end of 2020, it
is unlikely that the franchise will be retained beyond 2020. What amount should
be amortized for the year ended December 31, 2012?

Palmiero should amortize the franchise over its estimated useful life. Since it is
uncertain that Palmiero will be able to retain the franchise at the end of 2020, this
should be amortized over 10 years. The amount of amortization on the franchise
for the year ended December 31, 2012 is $35,000: ($350,000/10).

3. On January 1, 2010, Palmiero incurred organization costs of $275,000. What

amount of organization expense should be reported in 2012?

These costs should be expensed as incurred so $275,000 of organization expense

should have been reported for 2010.

4. Palmiero purchased the license for distribution of a popular consumer product on

January 1, 2012, for $150,000. It is expected that this product will generate cash
flows for an indefinite period of time. The license has an initial term of 5 years
but by paying a nominal fee, Palmiero can renew the license indefinitely for
successive 5-year terms. What amount should be amortized for the year ended
December 31, 2012?
 Since the license can be easily renewed at a nominal cost, it has an indefinite life.
This means that no amortization will need to be recorded; the license should be
tested for impairment in future periods.

Instructions

Answer the questions asked about each of the factual situations.

E12-5

(Correct Intangible Asset Account) As the recently appointed auditor for Hillary
Corporation, you have been asked to examine selected accounts before the 6-month
financial statements of June 30, 2012, are prepared. The controller for Hillary Corporation
mentions that only one account is kept for intangible assets.

Research and Development 940000

Patents 75000
Rent Expense 65000
Prepaid Rent 26000
Advertising expense 207000
Income summary (loss account) 141000
Discount on Bonds Payable 82950
Interest expense 1050
Paid in capital in excess of par (Common Stock) 250000
Intangible assets 1288000
Patent amortization expense 3125
Patents (Accumulated amortization) 3125
E12-12

(Accounting for Goodwill) Fred Graf, owner of Graf Interiors, is negotiating for the
purchase of Terrell Galleries. The balance sheet of Terrell is given in an abbreviated form
below.

Graf and Terrell agree that:

1. Land is undervalued by $50,000.

2. Equipment is overvalued by $5,000.

Terrell agrees to sell the gallery to Graf for $380,000.

Instructions

Prepare the entry to record the purchase of Terrell Galleries on Graf’s books.

Net assets of Terrell as reported 225000

Adjustments to fair value
Increase in land value 50000
Decrease in equipment value $ (5,000.00) 45000
Net assets of Terrell at fair value 270000
Selling price 380000
Amount of Goodwill to be recorded 110000

Journal entry will appear as follows:

Cash 100000
Land 120000
Building 200000
Equipment 170000
Copyright 30000
Goodwill 110000
Accounts payable 50000
Long-term notes payable 300000
Cash 380000
E12-16

(Accounting for R&D Costs) Margaret Avery Company from time to time embarks on a
research program when a special project seems to offer possibilities. In 2011, the company
expends $325,000 on a research project, but by the end of 2011 it is impossible to
determine whether any benefit will be derived from it.

Instructions

(a) What account should be charged for the $325,000, and how should it be shown in
the financial statements?

In accordance with FASB statement #2, the $325,000 is a research and

development cost that should be charged to R & D expense and, if not
separately disclosed in the income statement, the total cost of R & D should
be separately disclosed in the notes to the financial statements.

(b) The project is completed in 2012, and a successful patent is obtained. The R&D
costs to complete the project are $130,000. The administrative and legal expenses
incurred in obtaining patent number 472-1001-84 in 2012 total $24,000. The
patent has an expected useful life of 5 years. Record these costs in journal entry
form. Also, record patent amortization (full year) in 2012.

Research and Development Expense 130000

Cash 130000
(R & D development costs)

Patents 24000
Cash 24000
(Costs incurred to obtain patent)

Patent amortization expense 4800

Patents 4800
(One year amortization expense)
(c) In 2013, the company successfully defends the patent in extended litigation at a
cost of $47,200, thereby extending the patent life to December 31, 2020. What is
the proper way to account for this cost? Also, record patent amortization (full
year) in 2013.

Patents 47200
Cash 47200
(Cost of defending patent)

The cost of defending the patent is capitalized because the defense was successful
and it extended the useful life of the patent

Patent amortization expense 8300

Patents 8300

Carrying value after I year 19200

Cost to defend 47200
66400
(d) Additional engineering and consulting costs incurred in 2013 required to advance
the design of a product to the manufacturing stage total $60,000. These costs
enhance the design of the product considerably. Discuss the proper accounting
treatment for this cost.

By definition, since these costs “translate knowledge into a plan or design for
a new product”, the additional engineering and consulting costs required to
advance the design of a product to the manufacturing stage are R&D costs
and should be expensed as such.