Accounting for the Acquisition of Long-Lived Intangible Assets
Accounting for an intangible asset depends on how it is acquired.
1. Intangible Assets Purchased in Situations Other than Business Combinations
These are accounted for at acquisition costs. "Cost" includes purchase price, legal fees, and other expenses that make the intangibles ready for use. For example, fees paid to obtain a license or franchise are capitalized. Another example: expenditures on patents and copyrights purchased from another party are capitalized. They are amortized over their remaining legal lives or 40 years, whichever is less. The straight-line method is typically used for amortization.
2. Intangible Assets Developed Internally
For internally generated intangible assets, it is difficult to measure costs, benefits, and economic lives. Generally, internally generated assets (such as costs of R&D, patents and copyrights, brands and trademarks, and advertising and secret processes) must be expensed in the period incurred.
One exception is research and development (R&D) expenditures which add risk to investment with uncertain future economic benefits. As a result, they must be expensed as incurred in most countries (including the U.S.). SFAS 86 requires that all R&D costs to establish the technological and/or economic feasibility of software must be expensed. Subsequent costs that are beyond the point of technological feasibility can - but don't have to - be capitalized as part of product inventory and amortized based on revenues or on a straight-line basis. The point of technological feasibility is the point when a software prototype has been proven to be technologically feasible, as evidenced by the existence of a working model of the software.
IFRS also requires research costs be expensed but allows development costs to be capitalized under certain conditions.
As you can see, managers have considerable discretion in making decisions, such as whether or when to capitalize these costs and by how much. For software development costs, one particular risk is that capitalized costs will not be realized and a future write-down may be needed.
If companies apply different approaches to capitalizing software development costs, adjustments can be made to make the two comparable.
3. Intangible Assets Acquired in a Business Combination
Business combinations are accomplished when one entity (investor) acquires "control" over the net assets of another entity. The transaction is accounted for using the purchase method of accounting, in which the company identified as the acquirer allocates the purchase price to each asset acquired (and each liability assumed) on the basis of its fair value.
Any excess of cost over fair value of net assets acquired is recorded as goodwill.
U.S. GAAP requires that in-process R&D (IPRD) of the target company should be expensed at the date of acquisition, which results in a large one-time charge. IFRS requires identifying IFRD as a separate asset with a finite life or including it as part of goodwill.
Amortizing Intangible Assets with Finite Useful Lives
An intangible asset with a finite useful life is amortized over its useful life. The estimates required for amortization calculations are: original valuation amount, residual value at the end of useful life, and the length of useful life.
Torch, Inc. has developed a new device. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. The device has a useful life of 5 years. The legal life is 17 years. At the end of year 1, what is Torch's amortization expense?
Use the shorter of economic life (5 years) or legal life (17 years): Amortization = Cost / Useful Life = $3,000 / 5 = $600.
Intangible assets without a finite useful life (i.e., with an indefinite useful life) are not amortized, but are reviewed for impairment whenever changes in events or circumstances indicate that the carrying amount of an asset may not be recoverable.
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