Intangible assets

Question 1

What is an intangible asset?

Answer 1

An identifiable ( separable( can you sell it separately) from entity and have legal rights) non-monetary asset without physical substance.

Question 2

What are examples of intangible assets?

Answer 2

Goodwill, operating licences and franchises and patents.
R&D.

Question 3

What is goodwill?
What does goodwill capture?

Answer 3

Goodwill is the difference between fair value and book value of purchased asset.
a certain value (and potential competitive advantage) that may be obtained by one company when it purchases another

Question 4

Why are intangible assets important?

Answer 4

Intangible assets are an important source of strong competitive advantage for business and central to creating value e.g. patents help businesses protect their assets e.g. Apple their economic benefits comes from intangible asset, brand value, but not recognised on B/S.

Question 5

What is an example of accounting fraud with intangible assets?

Answer 5

WorldCom Inc the expenses they occurring were recorded on balance sheet and depreciated over a long useful life, thus increase profitability.

Question 6

When shall intangible assets we recognised in SOFP?

Answer 6

1) probable that future economics benefits attributable to the asset will flow to the entity
2) The cost of the asset must be measured reliably.
3) Control of the asset must also be demonstrated.

Question 7

An intangible asset is purchased separately then what is its cost?
If the asset is acquired in a business combination or an asset exchange, what is the cost.

Answer 7

1) cost is purchase price + Directly attributable costs in preparing asset for intended use.
2) cost is its fair value

Question 8

When we report intangible asset we report at cost but after that what 2 measurements techniques can we use?
What if the asset doesn’t have a finite life?

Answer 8

1) The cost model ( if asset has an infinite life its only subject to amortization.
2) The revaluation model.

Question 9

IAS 38 says that it is unlikely there is an active market for intangible assets, so what can we make an assumption off?

Answer 9

Salvage value = 0

Question 10

What happens with internally generated intangible assets ( e.g. promoting brand value by doing advertising) ?

Answer 10

They are not intangible assets, so cannot be capitalised, they are only expensed. This is because t is difficult to establish the true benefit from the asset or even to establish specific costs that can be attributable to items

Question 11

If you acquire an intangible assets, then can we capitalise and amoritise?

Answer 11

Yes we can, on the criteria that probable economic benefits can be demonstrated and costs measured reliably.

Question 12

What is development?

Answer 12

The design of protyotpes tools and the use of knowledge from research to the production of new products before it goes to the market.

Question 13

What is research? and are Research and development treated differently?

Answer 13

Expenditure undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
Yes they are.

Question 14

How do we treat Research?

Answer 14

Research expenditure is immediately charged to P/L in the year in which it is incurred.

Question 15

How do we treat development expenditure?

Answer 15

must be captialised when it meets all the criteria ( PIRATE ACRONYM
1) Probable future economic benefits
2) Intention to complete and use/sell it
3) Resources to complete the development
4) Ability to use or sell asset
5) Technical feasibility ( can actually be developed)
6) Expenditures reliably measured.

Question 16

Project A. The company spent £200,000 during the year. The directors of Map plc are very excited by initial results and think that in five years’ time they will be able to develop some new products based on the initial
results. How is this recognised?
Is the future economic benefits probable ?
Is the cost and benefit reliably measured?
Is the asset controlled by the firm?

Answer 16

Should be written off as an expense.
1) Yes
2) No ( management says they will be able to develop some new products based on initial results)
3) Yes

Question 17

Project B. It has been running for several years and accumulated costs on this project at the start of the year are £5,000,000. The project relates to the development of a new product in the final stages of testing before being manufactured for sale to customers.Project B (cont). The directors of Map plc are sure that the product is technically feasible. The directors expect that the product will be very
successful and are happy to provide technical and financial resources to complete the project. The costs of the project during the year can be reliably measured and include the following: (i) research staff (£300,000);
(ii) testing equipment (£100,000); (iii) overheads (£50,000). The testing equipment is depreciated using a rate of 20 per cent on a straight-line
basis.
Use the pirate criteria to judge this?

Answer 17

1) Probable future economic benefits Yes
2) Intention to complete and use/sell it Yes
3) Resources to complete the development Yes
4) Ability to use or sell asset Yes
5) Technical feasibility ( can actually be developed) Yes
6) Expenditures reliably measured. Yes
So we can capitalise this as its development cost

Question 18

What is subsquent measure of intangible asset?
Also does this change when the intangible asset has a finite useful life compared to infinite useful life?

Answer 18

Finite useful life ( software) = can amortise and impair the asset.
Infinite useful life ( Brands) = you cannot amoritse asset, only impair

Question 19

So when we are looking at intangibles what do we always have to make a distinction of?

Answer 19

Internally generated or purchased.

Question 20

When CA increases then this CA should be credited to the equity or OCI ( revalution surplus) in revaluation model. however if the same asset has been impaired what do we do?

If we have a decrease in CA, then CA should be Dr to P/L . If the asset was previously revalued in Revaluation surplus, then the decrease in CA should??

Answer 20

If same asset has been impaired and recognised on P/L then the increase in CA should be credited to income to the extent of reserval of impairments.

Should Dr equity to the extent of reversing such revaluation surplus.

Question 21

So we said its difficult to determine active market price of intangible assets, but sometimes we buy something and their price or cost is revealed through that transaction as goodwill is. If goodwill is purchased do we capitalise it, what is its measurement and does it have finite useful life?
Does it hit our 3 criteria of an intangible asset?

Answer 21

Goodwill = intangible asset = Capitalise
Measurement = cost
We cannot amortise it because it has an infinite useful life but can be impaired annually .
Control = Yes
Future economic benefits probable = yes
cost reliably measured = yes.
Remember Internally generated goodwill is expensed.

Question 22

What is Cash generating units again and how does it relate to goodwill.

Answer 22

the smallest identifiable group of assets that generates largely independent cash inflows.
Goodwill must be allocated to each of the acquirers CGU, which shall also be impaired.

Question 23

Lets look at Goodwill impairment, so remind me again when do we impair and what are the steps?

Answer 23

We impair when the CA > max{fair value less cost of disposal, value in use, 0).
So we impair by reducing the goodwill associated with it ( its generally the lowest CGU)
We reduce the CA of all the assits in the unit pro rata.

Question 24

Lets see how this works in a pratical example
1) And adjust Restate the table again
2) What would we do if 2000 in cash came from 1000 from Cash, 500 from PPE and 500 debt?

Answer 24

Question 25

Class exercise Facebook acquisition of WhatsApp? In which Facebook acquired 100% of Whatsapp shares for $19 billion, despite whatshad not shown any prior profitability, has reported total book value of assets far less than the price paid by Facebook but had impressive user growth. So price they paid from the outside looked very steep but What Strategic motives were perhaps fuelling interest in acquiring whatsapp?

Answer 25

1) A defensive move to keep someone like google from making the acquisition.
2) Obtaining and connecting to younger audience.
3) Increased users

Question 26

What is P/E ratio?

Answer 26

TBA
Price / EPS
Where EPS = Earnings/ shares
e.g. if P/E ratio = 30, it means its stock is trading 30 times its earnings per share.
Ideally a lower P/E ratio is desired when comparing 2 firms with same growth potentials, may signal that the stock price doesn’t accurately reflect the true value of the company based on its earnings.( undervalued) but it isn’t always bad to have a high P/E ratio( e.g. new innovation meaning company grows real quick)

Question 27

How might the $19 billion purchase price been derived?

Answer 27

Value cannot be derived from P/E ratio and compare to other companies as it has negative earnings, so P/E ratio not helpful.
However, what is key driver is users, so express this into price per user ( usually in the technology sector, as P/E ratio fails to identify value).
So 450 mil uses x $42 price per user gives around 19 billion.

Question 28

How will the intangible assets that Facebook acquired in the WhatsApp deal can be accounted for in the financial
statements going forward (IFRS perspective)?

Answer 28

Finite-lived: amortized over their useful life using straight-line amortization.
Infinite-lived: do not amortize
All recognised intangibles are tested for impairment
Goodwill is the largest intangible recorded from the WhatsApp deal ($15.34 billion), so most of the purchase price will be capitalized with no periodic effect on the income statement.

Question 29

Calculate the Dupont ratios for Facebook as of the end of 2013 and 2014 ( Hint to when calculating ratios show beginning and ending ratios for stock variables.

Answer 29

Question 30

What is another way of calculating OI?

Answer 30