APPLIED AUDITING

CHAPTER 6
AUDIT OF INTANGIBLE ASSETS

Objective
Solving Audit of Intangible Assets Problems

PROBLEM NO. 1
The following are items that could be included in the Intangible Assets:

1. Investment in a subsidiary company P1,500,000

2. Timberland 2,000,000
3. Cost of engineering activity required to advance the
design of a product to the manufacturing stage 120,000
4. Lease prepayments (6 months’ rent paid in 60,000
advance)
5. Cost of equipment obtained under finance lease 700,000
6. Internally generated publishing title 230,000
7. Costs incurred in the formation of the corporation 90,000
8. Operating losses incurred in the start-up of the 560,000
business
9. Training costs incurred in start-up operations 80,000
10. Purchase of a franchise 1,200,000
11. Goodwill internally generated 300,000
12. Cost of testing in search for product alternatives 65,000
13. Goodwill acquired in the purchase of a business 640,000
14. Cost of developing a patent 140,000
15. Cost of purchasing a patent from an inventor 500,000
16. Legal costs incurred in securing a patent 70,000
17. Costs of a successful legal suit to protect the patent 230,000
18. Cost of conceptual formulation of possible product
APPLIED AUDITING

alternatives 160,000
19. Cost of purchasing a copyright 900,000
20. Research and development costs 340,000
21. Long-term receivables 310,000
22. Cost of developing a trademark 61,000
23. Cost of purchasing a trademark 290,000
24. Computer software for a computer-controlled
machine that cannot operate without that specific 130,000
software
25. Operating system of a computer 10,000

Question:

How much could be recognized as Intangible Assets?

a. P3,600,000 c. P5,830,000
b. P3,740,000 d. P3,530,000

Suggested Solution:

PAS 38 par. 8 defines “Intangible asset” as an identifiable non-monetary asset

without physical substance.

Items 10, 13, 15, 16, 19 and 23 could be recognized as intangible asset.

The other items will be reported as follows:

Item 1 - Noncurrent asset in the balance sheet

Item 2 - Property, plant, and equipment in the balance sheet
Item 3 - Research and development expense in the income
statement
Item 4 - Current asset (prepaid rent) in the balance sheet
Item 5 - Property, plant, and equipment in the balance sheet
Item 6 - Not recognized. PAS 38 par. 63 states that internally
generated brands, mastheads, publishing titles,
customer lists and other items similar in substance
shall not be recognized as intangible assets. Any
costs related to creating publishing titles incurred
internally must be expensed.
Item 7 - Charge as expense in the income statement
Item 8 - Operating losses in the income statement
Item 9 - Charge as expense in the income statement
Item 11 - Not recognized. PAS 38 par. 48 states that internally
generated goodwill shall not be recognized as an
asset. Any costs related to creating publishing titles
incurred internally must be expensed.
Item 12 - Research and development expense in the income
statement
Item 14 - Research and development expense in the income
statement
Item 17 - Charge as expense in the income statement
APPLIED AUDITING

Item 18 - Research and development expense in the income

statement
Item 20 - Research and development expense in the income
statement
Item 21 - Noncurrent asset in the balance sheet
Item 22 - Charge as expense in the income statement
Item 24 - Property, plant, and equipment in the balance sheet
(see PAS 38 par. 4)
Item 25 - Property, plant, and equipment in the balance sheet
(see PAS 38 par. 4)

Answer: A

PROBLEM NO. 2

In connection with your audit of the Cabuyao Corporation, you noted the
following transactions during 2006:

Jan. 2 Paid legal fees of P450,000 and stock certificate

costs of P249,000 to complete organization of the
corporation.

15 Hired a clown to stand in front of the corporate office

for 2 weeks and hound out pamphlets and candy to
create goodwill for the new enterprise. Clown cost,
P30,000; pamphlets and candy, P15,000.

Apr. 1 Patented a newly developed process with costs as

follows:

Legal fees to obtain patent P1,287,000

Patent application and licensing 190,500
fees
Total P1,477,500

It is estimated that in 6 years other companies will

have developed improved processes, making the
Cabuyao Corporation process obsolete.

May 1 Acquired both a license to use a special type of

container and a distinctive trademark to be printed on
the container in exchange for 18,000 shares of
Cabuyao’s no-par common stock selling for P50 per
share. The license is worth twice as much as the
trademark, both of which may be used for 6 years.

July 1 Constructed a shed for P3,930,000 to house

prototypes of experimental models to be developed in
future research projects.
APPLIED AUDITING

Dec. Incurred salaries for an engineer and chemist

31 involved in product development totaling P750,000 in
2006.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Cost of patent
a. P1,477,500 c. P1,287,000
b. P 190,500 d. P 0

2. Cost of licenses
a. P450,000 c. P600,000
b. P300,000 d. P 0

3. Cost of trademark
a. P450,000 c. P600,000
b. P300,000 d. P 0

4. Carrying amount of Intangible Assets as of December 31, 2006

a. P2,137,812 c. P7,432,812
b. P2,092,812 d. P 0

5. Total amount resulting from the foregoing transactions that should be

expensed when incurred
a. P2,971,500 c. P5,424,000
b. P1,494,000 d. P 0

Suggested Solution:

The following journal entries to record the foregoing transactions will be

useful in computing for the requirements:

Jan. 2
Organization expenses P 699,000
Cash P 699,000

Jan. 15
Advertising expense P 45,000
Cash P 45,000

Apr. 1
Patents P1,477,500
Cash P1,477,500

May 1
Licenses (P900,000 x 2/3) P 600,000
Trademark (P900,000 x 1/3) 300,000
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Common stock (18,000 x P50) P 900,000

Jul. 1
Building P3,930,000
Cash P3,930,000

Dec. 31
Research and development expense P 750,000
Cash P 750,000

Question No. 1

See journal entry for April 1.

Question Nos. 2 & 3

See journal entry for May 1.

Question No. 4

Cost:
Patent P1,477,500
Licenses 600,000
Trademark 300,000 P2,377,500
Less amortization for 2006:
Patent (P492,500/6 x 9/12) 184,688
Licenses (P200,000/6 x 8/12) 66,667
Trademark (P100,000/6 x 33,333 284,688
8/12)
Carrying amount, 12/31/06 P2,092,812

Question No. 5

Organization expenses (Jan. 2 P 699,000

transaction)
Advertising expense (Jan. 15 45,000
transaction)
R and D expense (Dec. 31 transaction) 750,000
Total P1,494,000

Answers: 1) A; 2) C; 3) B; 4) B, 5) B

PROBLEM NO. 3

In connection with your audit of the Liliw Corporation’s financial statements for
the year 2006, you noted the following items relative to the company’s
Intangible assets.
APPLIED AUDITING

 A patent was purchased from Pansol Company for P4,000,000 on January

2, 2005. Liliw estimated that the remaining useful life of the patent to be 10
years. The patent was carried in Pansol’s accounting records at a carrying
value of P4,000,000 when Pansol sold it to Liliw.

 During 2006, a franchise was purchased from Makiling Company for

P960,000. In addition, 5% of the revenue from the franchise must be paid
to Makiling. Revenue from the franchise for 2006 was P5,000,000. Carter
estimates the useful life of the franchise to be 10 years and takes full year’s
amortization in the year of purchase.

 Liliw incurred research and development costs of P866,000 in 2006. Liliw

estimates that these costs will be recouped by December 31, 2009.

 On January 1, 2006, Liliw, because of the recent events in the industry,

estimates that the remaining life of the patent purchased on January 2,
2005, is only 5 years from January 1, 2006.
QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Amortization of patent for 2006

a. P900,000 c. P720,000
b. P800,000 d. P400,000

2. Carrying amount of patent as of December 31, 2006

a. P2,880,000 c. P2,700,000
b. P2,400,000 d. P3,200,000

3. Carrying amount of intangible assets as of December 31, 2006

a. P3,264,000 c. P3,564,000
b. P4,610,000 d. P3,744,000

4. Total amount that should be charged against income in 2006

a. P2,112,000 c. P2,012,000
b. P1,066,000 d. P1,932,000

Suggested Solution:

Question No. 1

Cost of patent P4,000,000

Less amortization in 2005 (P4,000,000/10) 400,000
Carrying amount, 1/1/06 P3,600,000
Divide by revised remaining useful life 5
Patent amortization for 2006 P 720,000

Question No. 2
APPLIED AUDITING

Carrying amount, 1/1/06 (see no. 1) P3,600,000

Less amortization in 2006 (see no. 1) 720,000
Carrying amount, 12/31/06 P2,880,000

Question No. 3

Cost of franchise P 960,000

Less amortization in 2006 (P960,000/10) 96,000
Carrying amount of franchise, 12/31/06 864,000
Carrying amount of patent, 12/31/06 (see 2,880,000
no. 2)
Carrying amount of intangible assets, P3,744,000
12/31/06

Question No. 4

Patent amortization (see no. 1) P 720,000

Franchise amortization (see no. 3) 96,000
Periodic franchise fee (P5,000,000 x 5%) 250,000
R and D expense 866,000
Total charged against income in 2006 P1,932,000

Answers: 1) C; 2) A; 3) D; 4) D

PROBLEM NO. 4

You gathered the following information related to the Patents account of the
Majayjay Cookie Corporation in connection with your audit of the company’s
financial statements for the year 2006.

In 2005, Majayjay developed a new machine that reduces the time required to
insert the fortunes into its fortune cookies. Because the process is considered
very valuable to the fortune cookie industry, Majayjay patented the machine.
The following expenses were incurred in developing and patenting the
machine:

Research and development laboratory expenses P1,000,000

Metal used in the construction of the machine 320,000
Blueprints used to design the machine 128,000
Legal expenses to obtain patent 480,000
Wages paid for the employees’ work on the
research, development, and building of the
machine (60% of the time was spent in 1,200,000
actually building the machine)
Expense of drawing required by the patent office
to be submitted with the patent application 68,000
Fees paid to the government patent office to
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process application 100,000

During 2006, Majayjay paid P150,000 in legal fees to successfully defend the
patent against an infringement suit by Cookie Monster Corporation.

It is the company’s policy to take full year amortization in the year of

acquisition.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Cost of patent
a. P580,000 c. P1,128,000
b. P648,000 d. P 798,000

2. Cost of machine
a. P1,236,000 c. P1,040,000
b. P1,648,000 d. P1,168,000

3. Amount that should charged to expense when incurred in connection with

the development of the patented machine
a. P1,480,000 c. P1,608,000
b. P1,000,000 d. P 0

4. Carrying amount of patent as of December 31, 2006

a. P522,000 c. P1,015,200
b. P583,200 d. P 837,900

Suggested Solution:

Question No. 1

Legal expenses to obtain patent P480,000

Expense of drawing required by the patent 68,000
office
Fees paid to the government patent office 100,000
Cost of patent P648,000

Question No. 2

Metal used in the construction of the P 320,000

machine
Blueprints used to design the machine 128,000
Wages paid to the employees (P1,200,000 720,000
x 60%)
Cost of machine P1,168,000
APPLIED AUDITING

Question No. 3

Research and development laboratory P1,000,000

expenses
Wages paid to the employees (P1,200,000 480,000
x 40%)
R & D expense P1,480,000

Question No. 4

Cost of patent (see no. 1) P648,000

Less amortization (P648,000 x 2/20) 64,800
Carrying amount of patent, 12/31/06 P583,200

Notes: 1) Cost of defending the patent should be expensed.

2) Since the useful life is not given, the patent was amortized using
the legal life of 20 years.

Answers: 1) B; 2) D; 3) A; 4) B

PROBLEM NO. 5

On January 2, 1998, Nagcarlan Company spent P480,000 to apply for and

obtain a patent on a newly developed product. The patent had an estimated
useful life of 10 years. At the beginning of 2002, the company spent P144,000
in successfully prosecuting an attempted patent infringement. At the
beginning of 2003, the company purchased for P280,000 a patent that was
expected to prolong the life of its original patent by 5 years. On July 1, 2006, a
competitor obtained rights to a patent that made the company’s patent
obsolete.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Carrying amount of patent as of December 31, 2002

a. P360,000 c. P369,600
b. P240,000 d. P355,200

2. Amortization of patent in 2003

a. P64,000 c. P52,000
b. P64,960 d. P63,520

3. Carrying amount of patents as of December 31, 2005

a. P448,000 c. P444,640
b. P454,720 d. P364,000
APPLIED AUDITING

4. Loss on patent obsolescence

a. P338,000 c. P448,000
b. P416,000 d. P364,000

Suggested Solution:

Question No. 1

Cost of patent P480,000

Less amortization up to 12/31/02 (P480,000 x 240,000
5/10)
Carrying amount of patent, 12/31/02 P240,000

Question No. 2

Amortization on original patent (P240,000/10) P24,000

Amortization on related patent (P280,000/10) 28,000
Total amortization in 2003 P52,000

Question No. 3

Original patent (P240,000 x 7/10) P168,000

Related patent (P280,000 x 7/10) 196,000
Carrying amount of patents, 12/31/05 P364,000

Question No. 4

Carrying amount of patents, P364,000

12/31/05
Less amortization, 1/1/06 to 7/1/06:
Original patent (P240,000/10 x P12,000
6/12)
Related patent (P280,000/10 x 14,000 26,000
6/12)
Loss on patent obsolescence P338,000

Answers: 1) B; 2) C; 3) D; 4) A
APPLIED AUDITING

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Reference:
Compilation of lecture notes by
Dean Rene Boy R. Bacay , CPA, CrFA, CMC, MBA, FRIAcc