Institute of Business and Accountancy

AUD02 – Auditing and Assurance: Concepts and Applications Part I R.A.A. Hipolito, CPA
AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS

Problem 1
The following situations are found in the records of the KILIMANJARO, INC. in your audit of the
company’s financial statements for the year ended December 31, 2021.

1. December 1, 2021:
Advertising expense 72,000
Cash 72,000
Payment of 2021 advertising contract.
2. Balance of Office supplies expense, Dec. 31, 2021 P45,000
Balance of unused office supplies, Dec. 31, 2021 15,000
Inventory of office supplies, Dec. 31, 2021 22,500
3. June 2, 2021
Prepaid insurance 54,000
Cash 54,000
Payment of one-year insurance premium for inventory.
4. Balance of factory supplies expense account, Dec. 31, 2021 P69,000
Physical inventory of factory supplies, Dec. 31, 2021 58,500
5. On May 1, 2021, a two-year subscription to the industry journal in the amount of P14,400 was paid.
Subscription expense was charged for the entire amount.

Required: Prepare the adjusting journal entries on December 31, 2021, based on the situations described.

Problem 2
The following information pertains to BAKER COMPANY’S Intangible assets
1. On January 1, 2021, Baker signed an agreement to operate as a franchisee of Max & Jess Food Chain,
Inc. for an initial franchise fee of P1,500,000. Of this amount, P300,000 was paid when the agreement
was signed and the balance is payable in 4 annual payments of P300,000 each, beginning January 1,
2022. The agreement provides that the down payment is not refundable and no future services are
required of the franchisor. The present value at January 1, 2021, of the 4 annual payments discounted
at 14% (the implicit rate for a loan of this type) is P874,000. The agreement also provides that 5% of
the revenue from the franchise must be paid to the franchisor annually. Baker’s revenue from the
franchise for 2021 was P19,000,000. Baker estimates the useful life of the franchise to be 10 years.

2. Baker incurred P1,300,000 of experimental and development costs in its laboratory to develop a patent
which was granted on January 2, 2021. Legal fees and other costs associated with registration of the
patent totaled P272,000. Baker estimates that the useful life of the patent will be 8 years.

3. A trademark was purchased from Banawe Company for P640,000 on July 1, 2018. Expenditures for
successful litigation in defense of the trademark totaling P163,200 were paid on July 1, 2020. Baker
estimates that the useful life of the trademark will be 20 years from the date of acquisition.

Requirement. Compute for the following:

a. Carrying value of the franchise at December 31, 2021
b. Carrying value of the patent at December 31, 2021
c. Carrying value of the trademark on December 31, 2021.
d. The total expenses resulting from the transactions that would appear on Baker’s income statement
for the year ended December 31, 2021.

Problem 3
KIWI CORPORATION was organized in 2020. Its accounting records include only one account for all
intangible assets. The following is a summary of the debit entries that have been recorded and posted
during 2020 and 2021.

AUD02_AY2223_S1_Handout No. 10 1|3

 Institute of Business and Accountancy

AUD02 – Auditing and Assurance: Concepts and Applications Part I R.A.A. Hipolito, CPA
INTANGIBLE ASSETS
July 1, 2020 8-year franchise; expires June 30, 2028 P 162,000
Oct. 1, 2020 Advance payment on leasehold (term of lease is 2 years) 84,000
Dec. 31, 2020 Net loss for 2020 including incorporation fee, P3,000, and related
legal fees of organizing P15,000 (all fees incurred in 2020) 48,000
Jan. 2, 2021 Acquired patent (10-year life) 222,000
Mar. 1, 2021 Cost of developing a secret formula 225,000
April 1, 2021 Goodwill purchased 835,200
July 1, 2021 Legal fee for successful defense of patent purchased above 37,950
Oct. 1, 2021 Research and development costs 480,000

Requirement. Ignoring income tax effect, compute for the following:

a. Unamortized patent cost at December 31, 2021
b. Unamortized franchise cost at December 31, 2021
c. The amount of prepaid rent to be reported in Kiwi’s December 31, 2021 statement of Financial
Position
d. Net debit to the retained earnings account as a result of adjusting entries on December 31, 2021
e. Total charges against Kiwi’s 2021 income as a result of the adjustments at December 31, 2021

Problem 4
The following cost were incurred by EVEREST COMPANY during 2021:
a. Searching for applications of new research findings. P 57,000
b. Trouble-shooting in connection with breakdowns during commercial production. 87,000
c. Adaptation of an existing capability to a particular requirement or customer’s
need as a part of continuing commercial activity. 39,000
d. Engineering follow-through in an early phase of commercial production. 45,000
e. Radical modification of the formulation of a glassware product. 78,000
f. Laboratory research aimed at discovery of new knowledge. 204,000
g. Testing for evaluation of new products. 72,000
h. Quality control during commercial production, including routine testing of
products. 174,000
i. Materials consumed in research and development projects. 177,000
j. Consulting fees paid to outsiders for research and development projects. 300,000
k. Personnel costs of persons involved in research and development projects 384,000
l. Indirect costs reasonably allocable to research and development projects. 150,000
m. Materials purchased for future research and development projects. 102,000
n. Research and development costs reimbursable under a contract to perform
research and development for Client Corporation. 1050,000
o. Design, construction, and testing of preproduction prototypes and models. 870,000
p. Routine on-going efforts to refine, enrich, or otherwise improve upon the qualities
of an existing product. 750,000
Total P 4,539,000

Requirement. Compute for the total amount to be classified and expensed as research and development for
2021.

Problem 5
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 now owned by the company.

 During 2015 and 2016, Emi Koussi spent a total of P459,000 in developing a new process that was
patented (Patent A) on April 1, 2017; additional legal and other costs of P50,000 with incurred.
 A patent (Patent B) developed by Nonoy Inventor, an inventor, was purchased for P187,500 on
December 1, 2018, on which date it had an estimated useful life of 12 ½ years.

AUD02_AY2223_S1_Handout No. 10 2|3

 Institute of Business and Accountancy

AUD02 – Auditing and Assurance: Concepts and Applications Part I R.A.A. Hipolito, CPA
 During 2017, 2018, and 2019, research and development activities cost P510,000. No additional
patents resulted from these activities.
 A patent infringement suit brought by the company against a competitor because of the manufacture
of article infringing on Patent B was successfully prosecuted at a cost of P42,000. A decision in the
case was rendered in June 2019.
 On July 1, 2020, Patent C was purchased for P172,000. The patent had 16 years yet to run.
 During 2021, Emi Koussi expended P180,000 on patent development. However, the company is still
undecided as to how the patent, if approved by the Bureau of Patents, will generate probable future
economic benefits.
 Assume that the legal life of each patent is also its useful life.

Requirement. Compute for the following:

a. Patent A’s carrying value on December 31, 2021.
b. Patent B’s carrying value on December 31, 2021.
c. Patent C’s carrying value on December 31, 2021.
d. Total patent amortization expense to be reported in Emi Koussi’s income statement for the year
ended December 31, 2021.

Problem 6
ANDES CORPORATION expended P510,000 in research and development costs. These activities resulted to
a new product called the Oido Organ. It was patented at additional legal and other costs of P54,000. The
patent application was filed on October 1, 2017, and the patent was estimated to have a useful life of 10
years.

On June 1, 2019, Andes spent P28,440 to successfully prosecute a patent infringement. In addition, the
patent’s estimated useful life was extended to 12 years from June 1, 2019. At the beginning of 2021, Andes
determined that a competitor’s product would make the Oido Organ obsolete and the patent worthless by
December 31, 2022.

Requirement. Based on the preceding information, calculate the patent amortization expense from 2017 to
2021.

Problem 7
BRANDY COMPANY has two cash generating units. On December 31, 2021, the assets of one cash
generating unit at carrying amount are:

Inventory 200,000
Accounts receivable 300,000
Plant and equipment 6,000,000
Accumulated depreciation 2,600,000
Patent 850,000
Goodwill 100,000

The accounts receivables are regarded as collectible and the inventory’s fair value less cost to sell is equal
to the carrying amount. The patent has fair value less cost to sell of P750,000.

On December 31, 2021, Brandy Company undertook impairment testing of the cash generating unit and
determined the value in use of the unit at P4,050,000.

REQUIREMENT. Compute the impairment loss of the cash generating units and the amount of Plant and
Equipment at December 31, 2021.

- END -

AUD02_AY2223_S1_Handout No. 10 3|3