CPA REVIEW SCHOOL OF THE PHILIPPINES AP-9004

Manila
AUDITING PROBLEMS CPA Review

AUDIT OF INTANGIBLES

PROBLEM NO. 1

Information concerning ROBOT CORPORATION’s intangible assets is as follows:

1. On January 1, 2021, Robot Corporation signed an agreement to operate as a franchisee of

Patok Copy Service, Inc., for an initial franchise fee of P255,000. Of this amount, P75,000
was paid when the agreement was signed and the balance is payable in four annual payments
of P45,000 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 implicit interest
rate for a loan of this type on January 1, 2021, is 14%. The agreement also provides that 5%
of the revenue from the franchise must be paid to the franchisor annually. Robot’s revenue
from the franchise for 2021 was P2,700,000. Robot estimates the useful life of the franchise
to be ten years.

2. Robot incurred P234,000 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 P49,200. Management estimates that the useful life of the
patent will be eight years.

3. A trademark was purchased from Salonga Company for P120,000 on July 1, 2018.
Expenditures for successful litigation in defense of the trademark totaling P30,000 were paid
on July 1, 2021. Management estimates that the useful life of the trademark will be 20 years
from the date of acquisition.

Questions:

1. What is the carrying amount of the franchise on December 31, 2021?

A. P185,505 B. P206,116 C. P225,000 D. P229,500

2. What is the carrying amount of the patent on December 31, 2021?

A. P43,050 B. P204,750 C. P247,800 D. P277,050

3. What is the carrying amount of the trademark on December 31, 2021?

A. P99,000 B. P114,000 C. P123,750 D. P129,000

4. What is the total amortization expense in 2021?

A. P32,762 B. P37,650 C. P47,762 D. P62,012

5. What is the total amount of intangibles-related expenses (excluding amortization) that

should be reported in the income statement for the year ended December 31, 2021?
A. P153,356 B. P165,000 C. P183,356 D. P190,200

PROBLEM NO. 2

In your audit of the books of DIEHARD CORP. for the year ended December 31, 2021, you found
the following items in connection with the company’s patents account.

a) Diehard had spent P120,000 during the year ended December 31, 2020, for research and
development costs. This amount was debited to its patents account. The company’s cost

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records disclose that it had spent a total of P141,500 for the research and development of its
patents, of which P21,500 spent in 2020 had been debited to Research and Development
Expense.

b) The patents were issued on July 1, 2020. In connection with the issuance of the patents, the
company incurred legal expenses of P14,280, which were debited to Legal and Professional
Fees Expense.

c) On January 5, 2021, Diehard paid a retainer of P15,000 for legal services in connection with
a patent infringement suit brought against it. Deferred Costs was charged for the amount.

d) In reply to your inquiry about the company’s liabilities as of December 31, 2021, you received
a letter from the company’s legal counsel dated January 20, 2022, which indicated that a
settlement of the patent infringement suit had been arranged. The plaintiff will drop the suit
and release the company from all future liabilities in exchange for P20,000. Additional lawyer’s
fees were incurred amounting to P1,260.

REQUIRED: Prepare the necessary adjusting journal entries, excluding entries for amortization.

PROBLEM NO. 3
The TERRAN COMPANY acquired several small companies at the end of 2020 and, based on the
acquisitions, reported the following intangibles in its December 31, 2020, statement of financial
position:
Patent P200,000
Copyright 400,000
Tradename 350,000
Computer software 100,000
Goodwill 900,000

The company’s accountant determines the patent has an expected life of 10 years and no
expected residual value, and that it will generate approximately equal benefits each year. The
company expects to use the copyright and tradename for the foreseeable future. The accountant
knows that the computer software is used in the company’s 120 sales offices. The company has
replaced the software in 60 offices in 2021, and expects to replace the software in 40 more offices
in 2022 and the remainder in 2023.

On December 31, 2021, there are no indications of impairment of patent and computer software.
The following information relates to the other intangible assets.

a) Because of the rampant piracy, the copyright is expected to generate cash flows of just
P8,000 per year.

b) The tradename is expected to generate cash flows of P15,000 per year.

c) The goodwill is associated with Terran’s SCV Manufacturing reporting unit. The cash flows
expected to be generated by the SCV Manufacturing reporting unit is P200,000 per year for
the next 25 years. The reporting unit has a carrying amount of P3,000,000.

Based on the above and the result of your audit, determine the following: (Assume that the
appropriate discount rate for all items is 5%.)

1. Total amortization of intangible assets in 2021

A. P70,000 B. P88,750 C. P107,500 D. P20,000
2. Total loss on impairment in 2021
A. P452,470 B. P530,280 C. P471,220 D. P433,720

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3. Carrying amount of goodwill on December 31, 2021

A. P900,000 B. P718,780 C. P855,000 D. P659,720
4. Carrying amount of other intangible assets on December 31, 2021
A. P690,000 B. P980,000 C. P640,000 D. P706,667

PROBLEM NO. 4
BANAWE COMPANY began operations on January 2, 2013. Shown below is the company’s trial
balance prepared by its staff accountant for December 31, 2021.
(in thousands of pesos)
Debit Credit
Cash P 60
Accounts receivable 150
Inventory 360
Equipment 2,400
Accumulated depreciation – Equipment P 750
Buildings 3,600
Accumulated depreciation – Buildings 1,200
Patents 1,650
Franchise agreement 285
Organization costs 306
Goodwill 1,035
Accounts payable 36
Accrued wages payable 15
Accrued taxes payable 180
Bonds payable 1,500
Premium on bonds payable 105
Preference shares (P100 par value) 300
Ordinary shares (P25 par value) 3,300
Premium on share capital 660
Retained earnings (as of January 1) 1,200
Sales 2,700
Cost of goods sold 1,200
Selling and administrative expenses 900
P11,946 P11,946
As a member of the audit team for Banawe Company, you have been assigned the audit of the
company’s intangible assets. Your investigation reveals the following:

Patents
The patents, acquired January 2, 2014, are being amortized over an expected useful life of 14
years. Improvements made to equipment covered by the patents costing P225,000 were debited
to the account in January 2018. Amortization in 2018-2020 included amortization on the
P225,000 for the remaining life of the relevant patent. It is determined that the P225,000 should
have been expensed in 2018. It is further determined on December 31, 2020, that one of the
patents has a remaining life of only 2 years. This patent was originally assigned a cost of
P630,000.

Franchise Agreement
A franchise agreement was signed on January 1, 2021. A P150,000 fee was paid, covering a 5-
year period, at the end of which the company may renew the agreement by paying P150,000. A
decision on renewal has not been made as of December 31, 2021. The agreement calls for an
annual payment of 5% of revenue. An entry debiting the account for P135,000 was made at the
time of the cash payment for 2021.

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Organization Costs
Organization costs include the unamortized portion of amounts paid to promote for services
rendered at the inception of the corporation. These fees have been amortized, since inception,
over an estimated 40-year life. The decision is made, as of December 31, 2021, to reduce the
total period of amortization of organization costs to 12 years.

Goodwill
The goodwill account includes the following:
P135,000 -- Legal expenses relative to incorporation. These were assigned to the account in
January 2013.
P600,000 -- Excess of cost over assigned net asset values of an enterprise acquired in early
2019 expected to be of value for an indefinite period.
P300,000 -- Paid to an advertising consulting firm in early 2020 for a major advertising effort
expected to be beneficial for an indefinite period.
No amortization has been taken on any amount in the Goodwill account.

1. What is the carrying value of the Patents on December 31, 2021?

A. P1,211,786 B. P1,009,286 C. P1,166,786 D. P1,256,786

2. What is the carrying value of the Franchise Agreement on December 31, 2021?
A. P120,000 B. P228,000 C. P123,000 D. P112,500

3. What is the carrying value of the Organization Costs on December 31, 2021?
A. P171,000 B. P 0 C. P417,375 D. P194,625

4. What is the carrying value of Goodwill on December 31, 2021?

A. P1,035,000 B. P585,000 C. P1,009,125 D. P600,000

5. What is the total Patent amortization for 2021?

A. P370,714 B. P168,214 C. P315,000 D. P325,714

PROBLEM NO. 5

1. The most effective means for the auditor to determine whether a recorded intangible asset
possesses the characteristics of an asset is
A. Vouch the purchase by reference to underlying documentation.
B. Inquire as to the status of patent application.
C. Evaluate the future revenue-producing capacity of the intangible asset.
D. Analyze the research and development expenditures to determine that only those
expenditures possessing future economic benefit have been capitalized.

2. In auditing intangible assets, an auditor most likely would review or recompute amortization
and determine whether the amortization period is reasonable in support of management’s
financial statement assertion of
A. Valuation C. Completeness
B. Existence D. Rights and obligations

3. Assuming TLL has capitalized all research and development costs associated with patent.
York, CPA, who is examining this account will probably
A. Confer with management regarding transfer of the amount from the balance sheet to
the income statement.
B. Confirm that the patent is registered and on file with the intellectual property office.
C. Confer with management regarding a change in the title of the account to “goodwill.”
D. Confer with management regarding ownership of the patent.

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4. Which of the following comparisons would be the most appropriate audit test for the amount
of recorded goodwill?
A. The purchase price and the book value of net tangible and identifiable assets purchased.
B. The purchase price and the fair value of net tangible and identifiable assets purchased.
C. The figure for goodwill specified in the contract of purchase.
D. Earnings in excess of 5% of net assets for the past five years.

5. A corporate balance sheet indicates that one of the corporate assets is a patent. An
auditor will most likely obtain evidence regarding the continuing validity and existence of
this patent by obtaining a written representation from
A. A patent attorney. C. The patent inventor.
B. The SEC. D. The patent owner.

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