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Chapter 12

Goodwill and Other Intangible Assets

Prepared by: Patricia Zima, CA Mohawk College of Applied Arts and Technology

Goodwill and Other Intangible Assets

Definition, Recognition and Measurement Characteristics Recognition and measurement at acquisition Measurement after acquisition Types of Impairment Intangibles of Intangible Marketing- Assets related Limited-life Customer- intangibles related Indefinitelife Artisticintangibles related other than Contractgoodwill based Technology- Goodwill based Goodwill Other Internally Developed Intangibles Research and development costs Development stage costs Organization costs Advertising costs Conceptual questions Presentation, Analysis, and International Comparison Presentation of intangible assets Perspectives Comparison of Canadian and International GAAP Appendix 12A Valuing Goodwill Excessearnings approach Totalearnings approach Other methods of valuation

Intangibles: Characteristics
CICA Handbook, Section 3062, broadly defines intangible assets as: 1. Assets that are lacking in physical substance, and 2. Assets that are not financial instruments Examples of intangible assets: patents, copyrights, franchises, and trademarks

Recognition and Measurement at Acquisition

Purchased Intangibles Measured at cost Cost includes all expenditures that are necessary to get the intangible asset ready for its intended use (e.g. purchase price, legal fees) If intangible assets are exchanged for non-monetary assets, the fair value of the item given up or the fair value of the intangible received is used to determine cost For a basket purchase of intangibles, the cost is allocated based on fair values

Recognition and Measurement at Acquisition

Identifiable intangibles: are recognized separately must have at least one of the following characteristics: 1. Results from contractual or legal rights, 2. They can be separated from the entity and sold, rented, exchanged, transferred or licensed Identifiable intangibles with similar characteristics should be grouped and reported together 5

Recognition and Measurement at Acquisition

Internally Developed Intangibles Costs that a company incurs internally to create intangibles (such as patents and brand names) are generally expensed Deferred Charges Costs incurred that benefit future periods It has become less acceptable to recognize deferred charges unless the costs meet the definition and recognition requirements of Section 1000

Accounting for the Acquisition Costs of Intangibles

Type 1. Identifiable Purchased Capitalize
Internally Created Generally expense Expense

2. Goodwill-type 3. Other internally developed


Capitalize restricted amounts for both


Measurement after Acquisition

An intangible asset with finite (or limited) useful life is amortized over its useful life Intangibles assumed to have no residual value, unless: 1. There is a commitment to purchase, or 2. There is an observable market An intangible asset with an indefinite useful life is not amortized and an impairment test is carried out at least annually

Valuation after Acquisition

Factors to consider when determining useful life of an intangible asset: 1. Expected future usage 2. Legal, regulatory, or contractual provisions that may limit useful life 3. Effects of technological or commercial obsolescence 4. Level of maintenance expenditures required to obtain future benefits Method of amortization chosen should match benefits received, otherwise, straight-line amortization used

Types of Intangibles
Six major categories for intangibles: 1. Marketing-related 2. Customer-related 3. Artistic-related 4. Contract-based 5. Technology-based 6. Goodwill


Marketing-Related Intangibles
Used in marketing and promotion Include: Trademarks or trade names Newspaper mastheads Internet domain names Non-competition agreements


Trademarks and Trade Names

Trademarks and trade names are renewable indefinitely every 15 years, so the legal life may be unlimited; the useful life, however, may be limited Costs of acquired trademarks or trade names are capitalized If trademarks or trade names are developed by the business, all direct costs are capitalized If the future benefits of a trademark (such as CocaCola) is determined to have an indefinite life, it is not amortized

Customer-Related Intangibles
Result from interactions with third parties Include: Customer lists Order/production backlogs Contractual and noncontractual customer relationships


Artistic-Related Intangibles
Ownership rights to artistic endeavours Examples: literary works, musical works, pictures, photographs and audiovisual material These ownership rights are protected by copyrights


Copyrights are granted for the life of the creator, plus 50 years Copyrights can be sold or assigned, but cannot be renewed Useful life is generally less than the legal life Amortized over period in which benefits accrue Costs of acquiring and defending copyrights are capitalized Research costs associated with a copyright are expensed

Contract-Based Intangibles
Value of a right resulting from a contractual arrangement Examples: licensing arrangement, leaseholds, construction permits, broadcast rights, service or supply contracts, franchises and licenses A franchise is a contractual agreement where franchisor grants the franchisee the rights to: sell specified products or services use certain trademarks or trade names perform certain functions within a particular geographical area

Franchises and Licenses

A franchise may exist for a limited time or for an indefinite time period The cost of a franchise (with a limited life) is amortized over the lesser of the legal or useful life A franchise (with an unlimited life) is amortized over: expected useful life if such life is deemed limited, or it is not amortized Annual operating payments for a franchise are expensed

Agreement between the lessor (owner) and the lessee (renter) Gives the lessee the right to use the property Valid for a specific period of time The lessee makes stipulated, periodic cash payments which are normally expensed Capital Leases: if the lease agreement transfers all benefits and risks to the lessee For capital leases, the PV of all future payments is recorded as a tangible asset and as a longterm liability

Leaseholds and Leasehold Improvements

Lease prepayments are reported as prepaid expenses, not as intangible assets Leasehold improvements are improvements made by the lessee to the leased property These leasehold improvements revert to the lessor at the end of lease term They are generally shown in the property, plant, and equipment section of the balance sheet, rather than with intangible assets

Technology-Based Intangibles
Relate to innovations or technological advances Include: 1. Product Patents Physical (tangible) products 2. Process Patents Process by which products are made 3. Computer Software Costs

A patent gives exclusive right to the holder for making, selling or using a product or process Costs of purchasing patents are capitalized Costs to research and most development costs are expensed as incurred Patents are amortized over the shorter of the legal life (20 years) or their useful lives Legal fees and other costs to successfully defend a patent are capitalized and amortized over the remaining useful life of the patent

Computer Software Costs

External Use Designed for resale Development costs treated as research and development costs Internal Use Designed for use within the organization Purchase cost and all direct costs of the software may be capitalized Any modifications to the software are capitalized if considered a betterment

Goodwill is the excess of the purchase price over the fair value of the identifiable tangible and intangible net assets acquired in a business combination Goodwill can be acquired and sold only when a business combination occurs Goodwill cannot be separated from the business Internally-generated goodwill is not capitalized Goodwill is the only intangible requiring separate disclosure on the balance sheet

Acquired Goodwill: Valuation

Given: Purchase price (cash): Book value of assets: Book value of liabilities: Fair value of assets:

$ 400,000 $ 255,000 $ 55,000 $ 350,000

To determine goodwill, see the following:


Acquired Goodwill: Calculation

Goodwill = Purchase price Fair value of identifiable net assets Goodwill = $400,000 less 350,000 = $50,000 Entry in the books of the Purchaser: Assets (various) 405,000 Goodwill 50,000 Liabilities 55,000 Cash 400,000

Negative Goodwill
Negative goodwill or a bargain purchase arises when fair value of acquired net assets is greater than the purchase price The current standard requires that: 1. The excess is used to reduce the amounts assigned to other acquired assets that are generally non-financial in nature, and 2. Any excess remaining is treated as an extraordinary gain

GoodwillValuation after Acquisition

Three approaches have been suggested: 1. Charge immediately to expense Results in consistent accounting for purchased goodwill and internally generated goodwill One rationale is that difficult to identify the useful life 2. Amortize over useful life Better matching of costs to benefits 3. Carry at cost indefinitely, unless value impaired Method approved by Accounting Standards Board Management is responsible for performing an impairment test 27

Intangible Asset Impairment Limited-Life Intangibles

Impairment occurs when carrying value of an asset is greater than fair value of the asset A recoverability test is necessary to determine whether the asset has been impaired If expected future cash flows is less than the carrying amount of the asset, asset is impaired If impairment, an impairment loss (carrying amount fair value) is recognized in the period, usually as part of continuing operations Same approach as for impairment of tangible assets

Limited-Life Intangibles Impairment

Carry amount of patent Recoverable amount Fair value (discounted amount) $6,000,000 3,500,000 2,000,000

Recoverability test? Indicates impairment (since $3,500,00 < $6,000,000) Impairment loss? $6,000,000 $2,000,000 = $4,000,000

Limited-Life Intangibles Impairment

Loss on Impairment 4,000,000 Accumulated Amortization, Patents 4,000,000

Remaining carrying amount amortized over expected useful life Future increases in value of intangible are not recognized

Indefinite-Life Intangibles Other than Goodwill - Impairment

Impairment test should be done annually Use fair value test only Fair value of intangible compared to the carrying amount When fair value is less than carrying amount, impairment has occurred and loss is recorded The recoverability test is not used for indefinite-life intangible assets

Goodwill Impairment
Two-step process 1. Fair value of the reporting unit compared to carrying amount of the reporting unit, including goodwill When fair value greater than carrying amount, no impairment When fair value less than carrying amount, then a second step is required 2. Determine if goodwill is impaired (see next slide)

Goodwill Impairment
Compare implied current fair value of goodwill with carrying amount of goodwill Implied current fair value of goodwill: Fair value of the whole reporting unit is compared to the fair value of the identifiable net assets When the fair value is less than carrying amount, impairment is recognized Goodwill impairment loss is reported separately in the income statement before extraordinary items and discontinued operations

Deferred Charges
Intangibles that may be recorded as deferred charges include: deferred development costs, pre-operating and start-up costs and organization costs CICA Handbook, Section 3070, Deferred Charges, removed from the handbook in 2005 Deferred charges are not as common as previously, as the costs must now meet the definition of an asset

Research and Development (R&D) Costs

R&D costs are not in themselves intangible assets Generally material in amount and generally lead to something that will be patented or copyrighted Challenges in R&D accounting: 1. Determining costs associated with a particular activity or project 2. Determining size of future benefits and for how long those benefits may be realized

Research and Development (R&D) Costs

CICA Handbook, Section 3450 governs the accounting for R&D costs: All research costs are charged to expense when incurred Development costs are charged to expense except in certain defined circumstances An exception to the above, may be able to capitalize if a company purchases in-process R&D as part of a business combination

Research and Development (R&D) Costs

Research activities: involve planned search or critical investigation aimed at discovery of new knowledge may or may not be directed towards a specific project Development activities include: translation of research findings or other knowledge into a plan or design for a new product or process, or significant improvement to an existing product or process

Research and Development (R&D) Costs

R&D costs include the following: 1. Materials and services consumed 2. Direct personnel costs (e.g. salaries) 3. Amortization of equipment and facilities used in R&D activities 4. Amortization of intangibles related to R&D activities 5. Reasonable overhead allocation Development costs are capitalized when all five of the following conditions are met and future benefits are reasonably certain 38

Research and Development (R&D) Costs

Development cost capitalization criteria: 1. Product/process clearly defined, and costs can be identified 2. Technical feasibility has been established 3. Managements intent is to produce and market or use the product/process 4. If the intent is to sell, a market is clearly defined; if the intent is to use, there is a definable use/need 5. Resources exist to complete the project

Pre-Operating Costs
Costs incurred prior to start of formal operations EIC-27 allows for the deferral of pre-operating costs if three conditions are met: 1. The expenditure relates directly to placing the new business in service 2. It would not have been incurred if not for the new business 3. The amount is likely to be recovered from future operations of the new business Amortized over maximum of 5 years

Other Deferred Charges

Organization Costs: Costs incurred to form a corporation (e.g. underwriter fees, legal fees) Usually recorded as an intangible asset They are usually amortized over a relatively short period of time (perhaps up to 5 years) Advertising Costs: No Canadian standard Usually expensed as difficult to measure future benefits

International Comparison
Canadian and international GAAP are substantially converged for intangible assets Some differences still exist related to the treatment of negative goodwill, preoperating costs, internally developed intangibles and impairment models of goodwill and other intangibles

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