Auditing Practice I I Third Term, AY 2013-2014

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UNIT2
AUDITOFINTANGIBLESANDOTHERASSETS
EstimatedTime:3HOURS
*UseLouwers4
th
edition

DiscussionQuestion2-1
1. Definethefollowingitems:
a. IntangibleAssets
b. Goodwill
c. GovernmentGrants
d. ExplorationCost
2. Whataretheinitialrecognitioncriteriaforintangibleassets?Howdoweinitiallyand
subsequentlymeasuretheseassets?
3. Brieflyexplainhowgovernmentgrantsareaccountedfor.
4. Briefly explain how Assets related to Exploration and Evaluation of Mineral
ResourcesareaccountedforinaccordancewithPFRS6.

DiscussionQuestion2-2:SubstantiveProceduresforIntangibleAssets

PleaserefertoLouwers10.52(seepage427and428).

Problem2-1IdentifyingIntangibleAssets

J. Dee Inc., a new corporation in the Philippines, incurred the following costs for the
periodendedJune30,2013:

Pre-openingcostofabusinessfacility P250,000
Purchasedrecipesandsecretformulas 150,000
Training,customerloyalty,andmarketshare 200,000
Licensing,royalty,andstandstillagreement 300,000
Operatingandbroadcastrights 112,300
Goodwillpurchasedinabusinesscombination 400,300
Alicensetomanufacturesteroidsbymeansofgovernmentgrant 333,780
Costofcoursestakenbymanagementinqualitycontrol 900,000
Atelevisionadvertisementthatwillincreasesales 200,000
Investmentinsubsidiary 1,100,000
6-monthadvancerental 200,000
Costofequipmentacquiredthroughfinancelease 780,000
Costincurredinthecorporationsformationandorganization 200,000
Internallydevelopedcustomerlist 250,000
Startuplosses 600,000
InitialFranchiseFeespaid 100,500
Continuingfranchisefees 80,000
Internallygeneratedgoodwill 120,000
Costoftestinginsearchforaproductalternative 200,000
Costofpurchasingapatent 150,000
Legalcostofacquiringapatent 180,000
Legalcosttodefendapatent 120,000
Costofmastheads 250,000
Computersoftwarewhichrequiresahardwaretooperate 130,000
Auditing Practice I I Third Term, AY 2013-2014
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Amount paid to a lessor for exclusive right to rent a facility for 10
years

125,000
Costofimprovementsonleasedfacility 50,000

Required:Howmuchisthetotalintangibleassets(includinggoodwill)?

Problem 2-2 Franchise Fees, Initial Recognition; Subsequent Measurement and

Impairment

On December 31, 2013, Thor Corporation (hereafter referred as the Company), a

subsidiaryofMarvelCorporationobtainedafranchisefromJaggerCorporationtosellfor
30yearsJaggerCorporationsproducts.Theinitialfranchisefeeasagreeduponshallbe
P40,000,000, payable in cash amounting to P10,000,000 when the contract is signed
and the remaining P30,000,000 is payable in three equal annual installment starting
December 31, 2014. A noninterest bearing note has been issued for the remaining
balance.Continuingfranchisefeeforyear2014amountedtoP500,000.AsofDecember
31,2013,theeffectiveinterestrateis12%.

During your 2014 audit fieldwork, you noted that the Accountant charged the initial
franchisefeeasanexpenseamountingtoP40,000,000.

Required:
a. Howmuchshouldthefranchisebeinitiallyrecognized?
b. WhatisthecarryingvalueofthefranchiseasofDecember31,2014?
c. What adjusting journal entries should be proposed correct the franchise
accountbalanceasofDecember31,2014?
d. Assumingthatthefranchisehasaninfinitelife,theexpectedyearlycashflow
isP4,000,000,andthattheprevailingmarketrateasofDecember31,2014is
13%,whatamountofimpairmentlossshouldberecognizedonthefranchise?

Problem2-3Patent,InitialRecognition,SubsequentMeasurement,andImpairment

Adele Inc. currently owns a very important patent on its machine which prevents air
pollution.AdeleInc.researchanddevelopsproductsandprocessesthatitpatents.The
followingtransactionshappened:

2011-2012 Researchtoacquirenewknowledge P 9,840,000

Jan. 5,2013 Designandconstructionofprototype 976,200
Mar.15,2013 Testingtheprototypemodels 320,000
Jan. 5,2014 Legalfeestoprocesspatent 620,000
Dec.10,2016 Legalfeestodefendapatent 387,000
Jan. 5,2019 Acquisitionoftherelatedpatentwhichextends
usefullifeby2years 654,385
Dec.31,2021 Legalfeespaidinunsuccessfuldefenseofthe
patent 280,000

Required:
a. Atwhatamountshouldthepatentbeinitiallyrecognized?
b. Whatisthecarryingvalueofthepatenton
a. December31,2014?
b. December31,2016?
Auditing Practice I I Third Term, AY 2013-2014
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c. December31,2019?
c. What is the amount of impairment loss to be recognized in 2021 due to loss on
patentinfringement?

Problem2-4ResearchandDevelopmentCostCapitalization

JJUD Semiconductor Company incurred R&D costs relating to its undertaking on the
HumanMicrochipImplantProject,anintegratedcircuitmicrochipthatisimplantedintoa
humans body. Such implants can be used for information storage, including personal
identification,medicalhistory,allergies,contactinformationincaseofemergency,etc.

Machinerycustomizedtomanufacturemicrochipimplant....1,200,000
Depreciationoftheaboveequipment..120,000
Allowancetohumanhostsusedinexperiments..600,000
ConsultingfeesofDr.Warwick,ofCyberneticsDept..300,000
Modificationonthedesignofmicrochip.405,000
Designoftools,jigs,moldsanddiesinvolvedinnanotechnology.510,000
Labresearchaimedatdiscoveryofnanotechnology....555,000

The accountant capitalized machinery amounting to P1,200,000 as PPE although it

doesnthaveanyalternativeuse,whiletherestwereexpensedintheP/LasR&D.

On January 1, 20x1, NXP received the approval from the NTC, DOST, and BFAD to
marketitsdeviceinthePhilippines.Sinceitsapproval,about100hospitalshaveelected
tousethesystem.

Rawmaterialssilicon,microprocessor,etcforitsprototype.156,000
Troubleshootingduringbreakdownduringcommercialproduction...450,000
Routineongoingeffortstorefineandimprovetheexistingproduct..125,000
Design,construction,testingofpre-productionprototype....110,000
Qualitycontrolduringcommercialproduction.150,000

TheaccountantexpensedallthesetransactionsintheP/LasR&D.

Required:

1. ComputeforR&Dexpensein20x0;IntangibleAssetin20x0.
2. ComputeforR&Dexpensein20x1;IntangibleAssetin20x1.
3. Prepare adjusting journal entries, if necessary, to correct erroneous entries
pertainingtoresearchanddevelopmentexpense(assume20x0booksareclosed
anderrorsareonlycorrectedin20x1):
4. Ifthemachineryacquiredtomanufacturemicrochipwasexpensedin20x0dueto
lack of technology feasibility in 20x0, will it not be capitalized in 20x1 when the
Companyestablishedfeasibilityinthatyear?
5. How would your answer for Requirement No. 1 if the same machinery has
alternativeuseintheCompanysotheroperatingactivities?

Auditing Practice I I Third Term, AY 2013-2014

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Problem2-5OrganizationCost,AccountingTreatmentandSubsequentMeasurement

Laviet Ooze, a company engaged in manufacturing and supplying donut syrup, is duly
organized, incorporated, and registered with the Securities and Exchange Commission
onFebruary16,20x1withaninitialpaidincapitalofP10million.Legalfeespaidtoan
independent CPA-Lawyer amount to P1 million. SECs registration fees cost P500
thousand.Entriestorecordarethefollowing:

On March 1, 20x0, the company patented its special formula of the Bavarian filling.
Legal fees paid to an independent CPA-Lawyer amount to P1 million. DTIs patent
application and license fees amount to P500 thousand.

On April 1, 20x0, the Company exchanged 2,000 shares of its P500 par value ordinary
shares for a special patent to be printed on the container of its syrup. At the time of the
exchange, ordinary shares are quoted at P550 per share.

On October 1, 20x0, the Company constructed a warehouse to house prototypes of
experimental syrups to be developed in future research projects. The total development
cost amount to P5 million and is expected to have a useful life of 25 years.

Salaries of an engineer and chemist involved in product developments totaled P700,000
for 20x0.

Per inspection of books, the accountant recorded all the transactions as follows:

Feb 16 Cash 10,000,000
Share Capital 10,000,000

Operating Expense - Fees 1,000,000
Cash 1,000,000

Intangibles - Organization Cost 500,000
Cash 500,000

Mar 1 Operating Expense Fees 1,000,000
Operating Expense License 500,000
Cash 1,500,000

Apr 1 Intangibles - Trademark 1,100,000
Share Capital 1,000,000
Share Premium 100,000

Oct 1 Property & Equipment 5,000,000
Cash 5,000,000

Dec 31 Operating Expense R&D salary 700,000
Operating Expense R&D depn 50,000
Cash 700,000
Acc. Depn 50,000

Required:
Auditing Practice I I Third Term, AY 2013-2014
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1. Cost of patent
2. Cost of capitalized R&D
3. Cost of trademark
4. Carrying amount of intangibles as of December 31, 20x0
5. Total amount charged to P/L for 20x0
6. Prepare the adjusting journal entries for 20x0

Problem2-5VariousMethodsofComputingGoodwill

On April 1, 2014, Elaine Mariano, a sole proprietor, is contemplating to acquire all the
issuedoutstandingordinarysharesofAcaInc.inabusinesscombinationaccountedfor
asapurchase.Therecordedassetsandliabilitiesareasfollows:

Cash P 840,000
Inventory 2,400,000
Propertyplantandequipment,net 3,500,000
Intangibleassets,withgoodwillofP600,000 1,400,000
Liabilities (1,900,000)

Onthesamedate,itwasdeterminedthattheproperty,plant,andequipmentofAcaInc.
hadasoundvalueofP4,400,000withestimatedremainingusefullifeofnineyears,and
itsidentifiableintangibleswithindefiniteusefullifehadafairvalueofP1,000,000.

Records show that the company earned accumulated net income of P4,650,000 from
2009-2013. The said profit include gain on disposal of fixed asset amounting to
P1,000,000andpresidentsannualbonusaveragingP150,000.NormalRateofReturnis
9%.

Required:
1. Computefor the net asset value to be used ingoodwill determination. How much is
thetotalearningsforACAusingtheadjustednetassetvaluebeforegoodwill?
2. ComputefortheaveragehistoricalearningsoftheCompany.
3. How much is the goodwill and assumed acquisition price under the following
assumptions:
a. Purchaseofexcessearningsoveraperiodof10years?
b. Excessearningscapitalizedat12%?
c. Averageearningscapitalizedat10%?
d. Purchase of excess earnings discounted using 10% over a period of 10
years?

Problem2-6GoodwillImpairment

On January 1, 2014, Indiana Jones Inc. acquired an 80% ownership interest in Crystal
SkullInc.forP1.6B.Asofthesamedate,CrystalSkullsidentifiablenetassetshavea
fairvalueofP1.5B.Theremaining20%ownershipisattributedtominorityinterest.The
assets of Crystal Skull together are the smallest group of asset that generates cash
inflows attributable to Goodwill. Therefore, Crystal Skull is the Cash Generating Unit
which requires to be tested for impairment on Goodwill. At the end of 2014, it is
determinedthat the recoverableamount of Crystal Skull as a CGU is P1B. Net lossof
CrystalSkullamountedtoP150Mfor2014.

Auditing Practice I I Third Term, AY 2013-2014

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Required:
a. Calculate the goodwill as of January 1, 2014 under the consolidated FS of
IndianaJonesInc.
b. Compute for the Impairment Loss to be recognized in 2014. Is this impairment
loss supposed to be attributed entirely in Goodwill or allocated over the
identifiableassetsorboth?
c. Assume that recoverable amount in 2015 is already P1.75 B instead. Is there
anyimpairmentrecoveryongoodwill?

Problem2-7GoodwillImpairment,CashGeneratingUnit

On January 1, 2013, Maggi Boy Inc. acquired Jepoy Inc. net assets for a total of
P10,000,000.JepoyInc.hasmanufacturingplantsinthreetowns.Thefairmarketvalues
oftheidentifiableassetsinthe3differenttownsarethefollowing:

Butuan P2,000,000
GeneralSantos 1,500,000
Aklan 4,500,000

At the beginning of 2014, a new town ordinance has been promulgated in Aklan
significantly restricting the resale of Maggi Boy Inc. main product. As a result, the
productionofMaggiBoyInc.inAklanwillbecutby30%.Onthesamedate,thecarrying
valuesofAklansnetassetsareasfollows:

Cash P 700,000
Receivables 1,800,000
Inventories 1,500,000
Propertyandequipment,net 2,700,000
Goodwill ?
Payables 700,000

Moreover,thecompanyoriginallyestimatedannualfuturenetcashflowsfromits
operationsinAklanatP1,500,000.MaggiBoyInc.usesstraightlinedepreciation
overa10yearlifefortheidentifiableassetsinAklanandanticipatesnoresidual
value since its acquisition. Prevailing market rate representing the time value of
moneyforthemanufacturingplantinAklanisestimatedtobeat15%.

Required:
a. Prepare a working paper showing the allocation of goodwill among the cash
generatingunits.
b. How much is the value in use of the cash-generating unit in Aklan as of
January1,2014?Howmuchimpairmentlossshouldbechargedtogoodwill?

Auditing Practice I I Third Term, AY 2013-2014

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Problem2-8:ComprehensiveProblem,VariousIntangibleAssets

ProvidedbelowarecertaininformationrelatedtoPottersintangibleassets:

A patent wasacquired onJanuary 2013 toprotect the production of amagic cloak that
made things appear invisible. Such cloak found a huge market in the Philippines,
consideringthehighincidenceofrobberiesinthecountry.Thefollowingwereincurred:

Legalexpensespaidtoobtainthepatent P500,000
Legalfeespaidindefendingthepatent 300,000
Feespaidtothegovernmenttoprocessapplication 225,000
Researchanddevelopmentexpenses 2,000,000
Laborwagesoftheengineersinresearchanddevelopment 125,000

On January of the current year, Hermione Company acquired a patent that rendered
Potters patent of manufacturing electronic books obsolete. The said patent had a
carryingvalueofP900,000asoflastbalancesheetdate.

DuetoitsrisingpopularityonJuly2014,manycompanieshavemadetheirownversion
of themagical cloak that makesthings disappear. Inordertoprotectthe market ofthe
existingproduct,PotteracquiredanotherpatentatacostofP435,000.Theusefullifeof
theotherpatentisonly15yearsfromdateofacquisition.

Inordertohaveanoutletforitsproducts,PotterCompanyoptedtoacquireafranchiseof
DobbylinkinJuly2012.ThecostofacquiringthefranchiserequiredPotterCompanyto
give a down payment of P400,000 and annual payments of P100,000 for the next six
years.PotterCompanycanborrowat12%interestrateforaloanofthistype.

(The franchise is said to have a useful life of ten years. The franchise also charged
Potter2%oftotalsalesduringtheyear.SalesfortheyeartotaledP1,200,000.)

Aspartofitsexpansion,PotterCompanydecidedtoacquire80%ofthevotingsharesof
Dumbledore Company on May 2014. The company spent P1,000,000 all in all for the
saidshares.ThepartialbalancesheetofDumbledoreCompanybeforesuchacquisition
appearsasfollows:

Cash P54,000
AccountsReceivable 200,000
PropertyPlantandEquipment 1,000,000
Inventory 500,000
AccountsPayable 450,000
NotesPayable 360,000

All are said to be at their current fair market value, except for property plant and
equipmentwhichissaidtobeundervaluedbyP100,000witharemainingusefullifeof10
yearsandnoresidualvalue.

Auditing Practice I I Third Term, AY 2013-2014

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Required:ComputeforthefollowingasofDecember31,2014.

1. Patent
2. Franchise
3. Amortizationofintangibles
4. Goodwill(consolidatedFS)
5. IntangibleAssets(consolidatedFS)
6. Totaleffectoftheforegoingtransactionstonetincomein2014(ParentFS)

Problem2-9:AuditWorkingPaperPreparation

FCT & Company was engaged to audit Banawe Corporation. Banawe Corporation, a
well-knowncompanyintheinformationandtechnologyindustry,hadvariousintangibles
in its books as of the year ended December 31, 2014. The intangible account contains
thefollowing:

Patent P 700,000
Copyrights 180,000
Goodwill 450,000
ResearchNEMO 981,000

Yourauditdisclosedthefollowing:
1. The beginning balance of the intangible assets held by the Company are the
following:

Patent(remaininglifeof5yrs) P 200,000
Copyrights 110,000
Goodwill 500,000

2. OnJune30,2014,theCompanyacquiredanewpatentthroughissuing10,000of
itsowncommonstock.ExaminationshowedthattheCompanybookedthepatent
usingitsparvalueofP20/shareinsteadofP30/share.Theusefullifeofthenewly
acquiredpatentis10years.OnJuly1,2014,theCompanyincurredlegalcostto
defend its existing patent amounting to P300,000. The Company erroneously
capitalized this as patent cost. Amortization is yet to be booked on all the
Companyspatents.Noothertransactionsenteredthepatentaccount.

3. Thecompanyscopyrightwereaccountedforasfollows:

Copyright AcquisitionDate Cost Life

Barbel January1,2013 P 50,000 5
Marvel December1,2013 60,000 6
Carvel February1,2014 70,000 7

Noothertransactionsaffectedthecopyrightsaccount.
4. Goodwill account pertains to capitalized start up losses of the Company
amounting to P250,000 and goodwill acquired as part of business combination
amounting to P250,000. During the period, the Company booked P50,000
amortizationexpenseonitsgoodwillaccount.Noothertransactionsaffectedthis
account.
Auditing Practice I I Third Term, AY 2013-2014
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5. ResearchNEMOisaresearchprojectwhichconsistsofthefollowingcharges:

Salariesofresearchstaff P 281,000
Patentonlyfortheproject 180,000
Equipmentwithnootheruse 200,000
Patentwithalternativeuse 190,000
CostofPilotModels 130,000

Thepatentshaveusefullifeof10yearswhiletheequipmenthasausefullifeof4
years.Youhaveascertainedthattheequipmenthasbeenacquiredatthe
beginningoftheyearwhilethepatentswereacquiredafterthefirstsemester.
DepreciationandAmortizationisyettobebookedonthisaccount.
6. Therewerenoindicatorsthattheintangibleassetswereimpaired.Noimpairment
wasbookedbytheCompany.

Required:

a. Prepare an audit working paper presenting the correct balance of

intangibles,
b. Computeforthefollowing:
i. Totalamountofamortizationexpense,notincludingthosethatare
forresearch
ii. Totalresearchexpense
iii. Otheramountstobechargetocurrentyearsincome/loss
c. Doestheauditorneedtoperformatestofimpairment?Why?

CaseProblem:EthicsCase

RefertoAuditingandAssuranceServicesbyLouwerset.alExercise10.59.