UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS

NATURE AND CLASSIFICATION OF INTANGIBLE ASSETS  The assets are properly described and classified, and adequate disclosures have been
made in the financial statements
Intangible assets do not represent claims against others, nor do they represent rights in physically
existent properties; rather, they represent exclusive privileges to a product, process, or location. Audit Procedures:
The exclusive privilege may be granted by the government, as in the case of patents; or it may be
created, as in the case of goodwill; or it may be granted by an owner, as exemplified by a leasehold.  Obtain or prepare analysis of intangible assets
Normally, auditors will find documentary evidence available for inspection in connection with  Verify the accuracy of the analysis by performing tests of mathematical computations to
intangible asset verification which will serve as a guide to proper valuation and periodic the extent deemed necessary
amortization.  In an initial audit, examine transactions of prior period/s to determine if costs had been
capitalized in accordance with PAS 38, Intangible Assets.
AUDIT PROGRAM FOR PREPAYMENTS  In a recurring audit, trace the beginning balances to last year’s working papers
 Vouch current year transactions to supporting documentation
Audit Objectives:  Determine if the company’s amortization policies are in accordance with PAS 38.
Recalculate the amortization recorded.
To determine that:  Determine if there is proper allocation of the amortization recorded for the period
 Charges to prepayments represent amounts that are reasonably expected to be realized  Determine if there is impairment of value of intangible assets
through future operations  Determine propriety of financial statement presentation and adequacy of disclosures
 Prepayments are properly recorded
 The accounts are properly classified and described, and adequate disclosures have been PRACTICE PROBLEMS
made
1. The following situations are found in the records of KILIMANJARO, INC. in your audit of
Audit Procedures: the company’s financial statements for the year ended December 31, 2010.

 Obtain or prepare detailed analysis of the accounts 1. December 1, 2010

 Verify the accuracy of the analysis by performing tests of mathematical computations to Advertising expense 72,000
the extent deemed necessary Cash 72,000
 Determine the nature of the accounts included in the analysis Payment of 2011 advertising contract
 Determine the reasonableness of the amounts
 Examine supporting documentation 2. Balance of Office supplies expense, December 31, 2010 P 45,000
Balance of Unused office supplies, December 31, 2010 15,000
AUDIT PROGRAM FOR INTANGIBLE ASSETS Inventory of office supplies, December 31, 2010 22,000

Audit Objectives: 3. June 2, 2010

Prepaid insurance 54,000
To determine that: Cash 54,000
 The assets represent amounts that are reasonably expected to be realized through future Payment of one-year insurance premium for inventory
operations or otherwise, and that they are properly recorded.

Auditing Problems 1
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

4. Balance of Factory supplies expense account, December 31, 2010 P 69,000  Quality control during commercial production, including
Physical inventory of factory supplies, December 31, 2010 58,500 routine testing of products 174,000
 Materials consumed in research and development projects 177,000
5. On May 1, 2010, a two-year subscription to the Industry Journal in the amount  Consulting fees paid to outsiders for research and development
of P 14,400 was paid. Subscriptions expense was charged for the entire amount.
projects 300,000
 Personnel costs of persons involved in research and development
Prepare the adjusting journal entries on December 31, 2010, based on the situations
projects 384,000
described.
 Indirect costs reasonably allocable to research and development
2. You are engaged to audit the financial statements of AFOGNAT CO. for the year ended projects 150,000
June 30, 2010. Your audit revealed the following items in connection with the company’s  Materials purchased for future research and development projects 102,000
patents account  Research and development costs reimbursable under a contract
to perform research and development for Client Corporation 1,050,000
 Research and development costs of P 360,000 were incurred during the company’s  Design, construction, and testing of preproduction prototypes and
fiscal year ended June 30, 2009, and were charged to its patents account models 870,000
 The patent right was granted on January 2, 2009. The account Legal and Professional  Routing on-going efforts to refine, enrich, or otherwise improve
Fees Expense was debited for P 15,000 in connections with the issuance of the patent upon the qualities of an existing product 750,000
 The company spent P 75,000 on July 5, 2009, for legal expenses in connection with a Total 4,539,000
patent infringement suit filed against it. This amount was charged to Deferred Costs
 The company received a letter from its lawyers on July 12, 2010. It indicated that an What is the total amount to be classified and expensed as research and development
amicable settlement of the lawsuit had been agreed. Afognat Co. would be released cost for 2010?
from all future liabilities in exchange for P 100,000. Accrued attorney’s fees totaled P
60,000 4. KIKIKTAT CORPORATION was organized in 2009. Its accounting records include only
one account for all intangible assets. The following is a summary of the debit entries
Prepare the adjusting journal entries on June 30, 2010, based on the foregoing that have been recorded and posted during 2009 and 2010:
information
INTANGIBLE ASSETS
3. The following costs were incurred by EVEREST COMPANY during 2010
7/1/2009 8-year franchise; expires June 30, 2017 P 126,000
 Searching for applications of new research findings P 57,000 10/1/2009 Advance payment on leasehold (term of lease is 2 years) 84,000
 Trouble-shooting in connection with breakdowns during 12/31/2009 Net loss for 2009 including incorporation fee, P 3,000, and
commercial production 87,000 related legal fees of organizing, P 15,000 (all fees incurred
 Adaptation of an existing capability to a particular requirement or in 2009) 48,000
customer’s need as a part of continuing commercial activity 39,000 1/2/2010 Acquired patent (10-year life) 222,000
 Engineering follow-through in an early phase of commercial 3/1/2010 Cost of developing a secret formula 225,000
production 45,000 4/1/2010 Goodwill purchased 835,200
 Radical modification of the formulation of a glassware product 78,000 7/1/2010 Legal fee for successful defense of patent purchased above 37,950
 Laboratory research aimed at discovery of new knowledge 204,000 10/1/2010 Research and development costs 480,000
 Testing for evaluation of new products 72,000

Auditing Problems 2
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

 The unamortized patent cost at December 31, 2010 should be? B. DANSKIN, INC. is considering purchasing A and B Enterprises, which has the following
 The unamortized franchise cost at December 31, 2010 should be? assets and liabilities.
 The amount of prepaid rent to be reported on KIKIKTAT’s December 31, 2010, Cost Fair Market Value
statement of financial position is? Accounts Receivable P 4,800,000 P 4,400,000
Inventory 4,800,000 5,000,000
 The adjusting entries on December 31, 2010, should include a net debit to the
Prepaid Insurance 200,000 200,000
retained earnings account of?
Buildings and Equipment (Net) 1,400,000 4,000,000
 As a result of the adjustments at December 31, 2010, the total charges against Accounts payable (3,200,000) (3,200,000)
KIKIKTAT’s 2010 income should be? Net Assets P 8,000,000 P 10,400,000

AUDIT OF PREPAYMENTS & INTANGIBLE ASSETS POST-TEST 5. If the purchase price is P 12,600,000, the amount of goodwill to be charged in
recording the acquisition is?
A. EMI KOUSSI CORP. has its own research department. However, the company purchases
patents from time to time. The following is a summary of transactions involving patents C. As a member of the audit team for the audit of RAS DESHEN COMPANY’s financial
now owned by the company. statements for the year ended December 31, 2010, you have been asked to examine
selected accounts. The controller for RAS DESHEN mentions that here is only one account
 During 2004 and 2005, Emi Koussi spent a total of P 459,000 in developing a new (shown below) kept for intangible assets.
process that was patented (Patent A) on April 1, 2006; additional legal and other costs
of P 50,000 were incurred INTANGIBLE ASSETS
 A patent (Patent B) developed by Nonoy Inventor, an inventor, was purchased for P
187,500 on December 1, 2007, on which date it had an estimated useful life of 12 ½ Date Particulars DR CR Balance
years 2/1 Stock issue costs 72,000 72,000
 During 2006, 2007, and 2008, research and development activities cost P 510,000. No 3/15 Research and development costs 1,880,000 1,952,000
additional patents resulted from these activities 4/3 Legal costs to obtain patent 150,000 2,102,000
 A patent infringement suit brought by the company against a competitor because of 5/1 Payment of 12 months’ rent on property leased 240,000 2,342,000
the manufacture of articles infringing on Patent B was successfully prosecuted at a 6/15 Promotional expenses related to business start-up 414,000 2,756,000
cost of P 42,600. A decision in the case was rendered in June 2008. 12/31 Unamort. bond discount on bonds due 12/31/ 30 168,000 2,924,000
 On July 1, 2009, Patent C was purchased for P 172,800. This patent had 16 years yet 12/31 Operating losses for first year 482,000 3,406,000
to run
 During 2010, Emi Koussi expended P 180,000 on patent development. However, the 6. The amount of organization expenses to be reported on RAS DESHEN’s income
company is still undecided as to how the patent, if approved by the Bureau of Patents, statement for the year ended December 31, 2010, is?
will generate probable future economic benefits. 7. What is the carrying value of the patent at December 31, 2010, assuming that its
useful life is 10 years?
1. What is Patent A’s carrying value on December 31, 2010? 8. The prepaid rent to be shown on RAS DESHEN’s statement of financial position at
2. What is Patent B’s carrying value on December 31, 2010? December 31, 2010?
3. What is Patent C’s carrying value on December 31, 2010?
4. What is the total patent amortization expense to be reported on Emi Koussi’s income
statement for the year ended December 31, 2010?

Auditing Problems 3
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION

D. ELGON COMPANY was organized in 2009 and began operations at the beginning of
2010. The company provides landscaping services. The following costs were incurred
prior to the start of operations:

Legal fees in connection with the organization of the company P 135,000

Improvements to leased office space prior to occupancy 225,000
Fees paid to underwriters for handling stock issue 36,000
Costs of meetings of incorporators to discuss organizational activities 63,000
Filing fee to incorporate 9,000

9. What is the total amount of organization costs that should be reported on

ELGON’s income statement?

E. DAURIAN COMPANY develops software for small businesses and home computer
markets. Most of the company’s 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. This
careful preparation has resulted to the production of several computer software
packages that have been very successful in the market place.

Daurian incurred the following costs during 2010:

Salaries and wages of programmers doing research P 705,000
Expenses related to projects prior to establishment of technological
feasibility 235,200
Expenses related to projects after technological feasibility has been
established but before software is available for commercial production 148,500
Amortization of capitalized software development costs from current
and prior years 80,250
Costs to produce and prepare software for sale 168,900

Additional data for 2010:

Sales and products for the year P 1,545,000
Beginning inventory 426,000
Portion of goods available for sale sold during year 60%
Income tax rate is 30%

10. What is Daurian’s net income for 2010?

Auditing Problems 4