In determining how to account for an intangible asset, the first question to answer is whether there is sufficient proof that it actually exists. The primary evidence that should be sought is documentation of either legal protection or a contract. Secondary evidence is provided by cash inflows created by the asset. In this latter situation, judgment must be carefully exercised. Authoritative bodies have resisted establishing rules because of the near impossibility of anticipating every situation. Consequently, identifiable assets are more commonly recognized than goodwill.
If an intangible asset is believed to exist, the next question is what amount should be associated with it. GAAP limit this figure to historical cost. Depending on the situation, there are several cost factors that should be considered:
- Costs paid to purchase the right or ability.
- Costs to obtain basic knowledge to create an ability (research).
- Costs to obtain knowledge relating to using the ability (development).
- Costs to obtain legal protection for the right or ability.
- Costs to maintain legal protection for the right or ability.
Because the costs of categories 1, 4, and 5 usually involve external transactions, judgments are more easily made about them than about categories 2 and 3.
GAAP for these assets are summarized in the matrix in below example. The practices vary among the four categories of intangibles:
- Purchased identifiable intangibles.
- Purchased unidentifiable intangibles.
- Internally generated identifiable intangibles.
- Internally generated unidentifiable intangibles.
Cost includes all amounts paid to obtain and protect the right or ability.
|Recognize asset only when acquired with other identifiable assets.
Cost equals excess of total paid over fair values of identifiable assets.
|Internally generated||Recognize asset.
Cost includes only amounts paid to protect the right or ability.
|Do not recognize asset.|
Purchased identifiable intangibles
There are no significant accounting problems related to purchased identifiable intangible assets that are not also encountered for tangible assets. For example, when a patent was acquired by the Sample Company by giving 10,000 shares of its $10 par value common stock known to be worth S18 per share, this journal entry would be made:
If a defense of a patent against infringement is successful, the net cost incurred should be capitalized because it will benefit future periods. For example, if $30,000 of legal fees were incurred, the following journal entry would be made:
Purchased unidentifiable intangibles
Because goodwill cannot be separated from a firm, it is not possible for a buyer to acquire it without also acquiring the firm. The cost of goodwill equals the excess of the total purchase price over the fair values of the tangible and identifiable intangible assets.
Suppose that the Sample Company acquires all the assets (except cash) of the XYZ Corporation by paying $1,800,000 and assuming long-term liabilities with a realistic present value of $1,200,000. Thus, the total cost is:
The fair values of the purchased identifiable assets were:
The cost of the goodwill is ($3,000,000 — $2,450,000) or $550,000. Sample Company would record the transaction with this journal entry:
The difference should be treated when the fair value of the identifiable assets exceeds the total cost paid.
Internally generated identifiable intangibles
Accounting practice concerning many internally generated identifiable assets (primarily research and development) was not uniform; these three approaches were used by different firms:
1. All expenditures were capitalized.
2. Some expenditures were capitalized and some were expensed.
3. All expenditures were expensed.
The first approach is virtually certain to overstate assets and understate expenses in the current year because not all expenditures will result in future benefits. The second approach is potentially the most useful because it assists in making comparisons of firms, but its implementation requires a set of guidelines to help the accountant judge which expenditures should be capitalized or expensed. The third approach is virtually certain to understate assets and overstate current expenses because some of the expenditures will produce useful knowledge and future benefits.
In specifying that the costs of research and development (R&D) be expensed when incurred, the Statement excludes (1) materials that will be consumed in future R&D efforts and (2) equipment and facilities that have “alternative future uses” (that is, they can be used for activities other than R&D). Both items eventually appear as R&D expenses when they are consumed either directly or indirectly through depreciation.
The capitalizable costs related to R&D include the costs of obtaining patent, trademark, or copyright protection as well as any subsequent expenditures needed to maintain that protection. Suppose that the Sample Company spent $42,100,000 during the year as follows:
If the laboratory building and equipment have alternative future uses but the special R&D equipment does not, the entry for the acquisitions and salaries would be:
Annual depreciation on the laboratory building and equipment would be recorded by this entry:
The costs of establishing the patent would be recorded this way:
This full expensing approach is not required for firms that perform R&D for other companies under contract.
Internally generated unidentifiable intangibles
Because the only evidence of internally generated goodwill is an above normal stream of earnings, accountants do not recognize it in externally presented balance sheets. There have not been any efforts by authoritative bodies to solve the problems of specifying how to identify and measure these earnings, nor does there seem to be any widespread interest in achieving this result. Consequently, internally generated unidentifiable intangible assets are not recognizable under GAAP.
Disclosures of intangibles
Below example shows the disclosures from the balance sheet and footnote disclosures of the Joy Manufacturing Company and the McDonald’s Corporation related to intangible assets.
Statement of Accounting Policies
Goodwill and the deferred credit, which arise from business combinations accounted for as purchase transactions, are amortized using the straight-line method over the periods estimated to be benefited. Amounts currently recorded are being amortized over 15-40 years.
Remaining costs of the underlying rights to the McDonald’s System trademarks and tradenames, acquired by the Company in 1961, amounted to at December 31, 2018 and 2017. The Company has reacquired certain unlimited term territorial franchise and operating rights. The unamortized cost of these rights amounted to and $14,701,000 at December 31, 2018 and 20177, respectively.
The Company and its subsidiaries have also reacquired limited term franchise rights in conjunction with the purchase of businesses operating McDonald’s restaurants under limited term franchise agreements. The unamortized costs of such rights totaled $26,302,000 and $25,468,000 at December 31, 2018 and 2017, respectively.