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AUDITING PRACTICE OCAMPO/OCAMPO

AP.3403 - Audit of Intangible Assets MAY 2023

SUBSTANTIVE AUDIT OF INTANGIBLE ASSETS

Existence: Recorded intangible assets exist Valuation and allocation: Intangible assets are valued in
accordance with GAAP
1. Obtain an analysis of ledger accounts for intangible
assets. 6. Vouch additions to or acquisitions during the year.

2. Examine documentation supporting intangible assets. 7. Evaluate dispositions and write offs during the year.

8. Evaluate amortization policy and verify computation of

Completeness: All intangible assets are recorded amortization.

3. Vouch additions to or acquisitions during the year.

Presentation and disclosure: Intangible assets are
4. Evaluate dispositions and write offs during the year. classified and disclosed in accordance with GAAP

9. Review financial statements and perform analytical

Rights and obligations: Intangible assets are owned by procedures to determine whether accounts are
the entity classified and disclosed in the financial statements in
accordance with GAAP.
5. Examine documentation supporting intangible assets.

INTERNAL CONTROL MEASURES

1. Acquisitions, dispositions and write offs of intangible assets should be properly authorized.

2. Adequacy and consistency of accounting policies governing intangible assets should be reviewed periodically.

3. General ledger account should be supported by adequate detailed records and they should be periodically reconciled.

4. Schedules of intangibles showing their cost and basis of amortization should be prepared periodically and reviewed by
a responsible official.

- end -

PROBLEM NO. 1
Apr.1 Patented a newly developed process with costs as
The accountant of the newly organized Zerg Corporation
follows:
provided to you the details of the company’s Intangible
Assets account as follows: Legal fees to obtain patent P429,000
Patent application and licensing fees 61,000
Intangible Assets
Total P490,000
Date Description Amount
01/02 Organization costs P 233,000 It is estimated that in 5 years other companies
01/15 Goodwill 15,000 will have developed improved processes, making
04/01 Patent 490,000 the Zerg Corporation process obsolete.
05/01 License and trademark 300,000
May1 Acquired both a license to use a special type of
07/01 R & D laboratory 1,310,000
container and a distinctive trademark to be
12/31 Product development costs 1,750,000
printed on the container in exchange for 6,000,
P4,098,000
no-par, ordinary shares of Zerg selling for P50
per share. The license is worth twice as much as
Transactions during 2022 included the following:
the trademark, both of which may be used for 5
Jan.2 Paid legal fees of P150,000 and other costs of years.
P83,000 to complete organization of the
Jul. 1 Constructed a shed for P1,310,000 to house
corporation.
prototypes of experimental models to be
15 Hired a clown to stand in front of the corporate developed in future research projects.
office for 2 weeks and hand out pamphlets and
Dec. Paid salaries for an engineer and chemist involved
candy to create goodwill for the new enterprise.
31 in research and development totaling P1,750,000.
Clown cost, P10,000; pamphlets and candy,
P5,000.
It is the company’s policy to take full year amortization in
the year of acquisition.

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TEAM PRTC
REQUIRED:
1. Prepare the necessary adjusting journal entries as of
Dec. 31, 2022.
2. Compute the carrying amount of the Intangible assets
as of Dec. 31, 2022.
3. Compute the total amount resulting from the foregoing
transactions that should be expensed when incurred.
4. The most effective means for the auditor to determine
whether a recorded intangible asset possesses the
characteristics of an asset is to
a. Evaluate the future revenue-producing capacity of
the intangible asset.
b. Vouch the purchase by reference to underlying
documentation.
c. Inquire as to the status of patent applications.
d. Analyze research and development expenditures to
determine that only those expenditures possessing
future economic benefit have been capitalized.
5. Assuming the company has capitalized all research and
development costs associated with patent. The auditor
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.
PROBLEM NO. 2
The Terran Company acquired several small companies
at the end of 2021 and, based on the acquisitions,
reported the following intangibles in its Dec. 31, 2021
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 2022, and expects to replace
the software in 40 more offices in 2023 and the remainder
in 2024.
On Dec. 31, 2022, there are no indications of impairment
of patent and computer software. The following
information relate 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 P2,100,000.
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QUESTIONS:
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 2022
a. P 70,000 c. P88,750
b. P107,500 d. P20,000
2. Total loss on impairment in 2022
a. P452,470 c. P471,220
b. P530,280 d. P433,720
3. Carrying amount of goodwill on Dec. 31, 2022
a. P900,000 c. P855,000
b. P718,780 d. P659,720
4. Carrying amount of other intangible assets on Dec. 31,
2022
a. P690,000 c. P980,000
b. P640,000 d. P706,667
5. Which statement is incorrect regarding audit of
intangible assets?
a. Accounting principles allow goodwill to be held on
the books of a company indefinitely and not
amortized over time.
b. Patents are amortized over the remaining legal life
or their useful life.
c. When testing a client's additions to an asset for
research and development, the auditor must
remember that such costs should be amortized
over the lesser of their legal lives or useful lives.
d. All the statements are correct.
PROBLEM NO. 3
The statement of financial position of Walsh Corporation as
of Dec. 31, 2021 reported the Intangible Assets, net as
follows:
Patent A P1,680,000
Patent B 2,450,000
P4,130,000
During the course of your audit, you noted the following.
a. Patent A was purchased for P1,920,000 on Jan. 1,
2020, at which date the remaining legal life was sixteen
years. On Jan. 1, 2022, Walsh determined that the
useful life of the patent was only eight years from the
date of acquisition.
b. On May 1, 2022, Walsh sold Patent B in exchange for a
P5,000,000 non-interest bearing note due on May 1,
2025. There was no established exchange price for the
patent, and the note had no ready market. The
prevailing rate of interest for a note of this type at May
1, 2022 was 14%. The patent was purchased for
P3,150,000 on Sept. 1, 2018. On that date, the
remaining legal life was fifteen years, which was also
determined to be the useful life.
c. On Jan. 3, 2022, in connection with the purchase of a
trademark from Joe Corporation, the parties entered
into a noncompetition agreement and a consulting
contract. Walsh paid Joe P8,000,000, of which three-
quarters was for the trademark and one-quarter was for
Joe’s agreement not to compete for a five-year period
in the line of business covered by the trademark.
Walsh considers the life of the trademark to be
indefinite. Under the consulting contract, Walsh agreed
to pay Joe P500,000 annually on Jan. 3 for five years.
The first payment was made on Jan. 3, 2022.
AP.3403
TEAM PRTC

d. At Dec. 31, 2022, Walsh determined the recoverable Item 2:

amount of the intangible assets as follows: On Jan. 3, 2021, Summer purchased two licensing
Patent A P1,350,000 agreements; at that time, they were believed to have
Trademark 5,500,000 unlimited useful lives. The balance in the Licensing
Noncompetition agreement 1,800,000 Agreement – A account included its purchase price of
P48,000 and P2,000 in acquisition expenses. Licensing
agreement – B also was purchased on Jan. 3, 2021 for
QUESTIONS: P50,000.

Based on the above and the result of your audit, determine Item 3:
the following: In Dec. 2021, an explosion caused a permanent 60 percent
reduction in the expected revenue-producing value of
1. Gain on sale of Patent B
Licensing Agreement – A, and in Jan. 2023, a flood caused
a. P2,620,000 c. P 995,000
additional damage, which rendered the agreement
b. P1,012,500 d. P 977,500
worthless.
2. Total amortization to be recognized in 2022
a. P680,000 c. P 767,500 Item 4:
b. P750,000 d. P1,950,000 A study of Licensing Agreement – B made by Summer in
Jan. 2022 revealed that its estimated remaining life
3. Total impairment loss to be recognized in 2022
expectancy was only 10 years as of Jan. 1, 2022.
a. P750,000 c. P550,000
b. P620,000 d. P 50,000
Item 5:
4. Intangible assets to be recognized in the statement of The balance in the Goodwill account includes P24,000 paid
financial position as of Dec. 31, 2022 Dec. 30, 2021, for an advertising program, which it is
a. P7,750,000 c. P8,450,000 estimated will assist in increasing Summer’s sales over a
b. P7,950,000 d. P8,850,000 period of four years following the disbursement.
5. In auditing intangible assets, an auditor most likely Item 6:
would review or recompute amortization and The Leasehold Improvement account includes (a) the
determine whether the amortization period is P15,000 cost of improvements with a total estimated
reasonable in support of management’s financial useful life of 12 years, which Summer, as tenant made to
statement assertion of leased premises in Jan. 2021; (b) movable assembly-line
a. Valuation. c. Existence equipment costing P8,500, which was installed in the
b. Completeness. d. Rights leased premises in Dec. 2022; and (c) real estate taxes of
P2,500 paid by Summer, which under the terms of the
lease, should have been paid by the landlord. Summer
PROBLEM NO. 4 paid its rent in full during 2022. A 10-year nonrenewable
Summer Manufacturing Corporation was incorporated on lease was signed Jan. 3, 2021, for the leased building that
Jan. 3, 2021. The corporation’s financial statements for its Summer used in manufacturing operations.
first year’s operations were not examined by a CPA. You
have been engaged to audit the financial statements for Item 7:
the year ended Dec. 31, 2022, and your work is The balance in the Organization Expenses account includes
substantially completed. A partial trial balance of the pre-operating costs incurred during the organizational
company’s accounts follows: period.

Account Title Debit Credit QUESTIONS:

Cash P11,000
Accounts receivable 42,500 1. The carrying amount of Patents as of Dec. 31, 2022 is
Allowance for doubtful accounts P 500 a. P85,000 c. P66,000
Inventories 38,500 b. P64,000 d. P46,000
Machinery 75,000 2. The carrying amount of Licensing Agreement – A as of
Equipment 29,000 Dec. 31, 2022 is
Accumulated depreciation 10,000 a. P20,000 c. P10,000
Patents (Item 1) 85,000 b. P0 d. P50,000
Leasehold improvements (Item 6) 26,000
Prepaid expenses 10,500 3. The carrying amount of Licensing Agreement – B as of
Organization expenses (Item 7) 29,000 Dec. 31, 2022 is
Goodwill (Item 5) 24,000 a. P66,000 c. P45,000
Licensing Agreement – A b. P85,000 d. P64,000
(Item 2 & 3) 50,000
4. The carrying amount of Leasehold Improvements as of
Licensing Agreement – B
Dec. 31, 2022 is
(Item 2 & 4) 50,000
a. P26,000 c. P13,500
b. P15,000 d. P12,000
Additional information:
5. The net adjustment to Retained earnings to reflect all
Item 1: the necessary corrections from Item 1 to 7 will amount
Patents for Summer’s manufacturing process were to
purchased Jan. 2, 2022, at a cost of P68,000. An additional a. P84,500 debit c. P83,000 debit
P17,000 was spent in Dec. 2022 to improve machinery b. P84,500 credit d. P55,400 debit
covered by the patents and charged to the Patents
account. The patents had a remaining legal term of 17 J - end of AP.3403 - J
years.

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