Acct 351 Chapter 12

Question 1

acquirer

Answer 1

A company that purchases another business

Question 2

active market

Answer 2

An instance of high activity in the trading of a particular security or exchange as a whole

Question 3

Artistic-related intangible assets

Answer 3

Ownership rights over the reproduction of a creative work. They are protected by copyright and have value because of their legal-contractual nature

Question 4

bargain purchase

Answer 4

The purchase of an investment at a price that is lower that the investee’s underlying book value. See negative goodwill

Question 5

brand (or brand name)

Answer 5

A group of assets such as a trade name and its related formulas, recipes, and technology

Question 6

business combination

Answer 6

When one entity acquires control over the net assets of another business, either by acquiring the net assets directly, or by acquiring the equity interest representing control over the net assets

Question 7

computer software costs

Answer 7

Technology-based intangible asset, either for internal use or for sale as a product

Question 8

Contract-based intangible assets

Answer 8

The value of rights that arise from contractual arrangements, such as liscensing agreements, lease agreements, and broadcast rights

Question 9

copyright

Answer 9

Is a federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations, whatever mode or form of expression. It is an exclusive right to reproduce and sell an artistic or published work

Question 10

cost recovery impairment model

Answer 10

According to this approach a long-lived asset is impaired only if an entity cannot recover the asset’s carrying amount from using the asset and eventually disposing of it

Question 11

Customer-related intangible assets

Answer 11

Occur as a result of interactions between company employees and systems with those interested in buying goods and services

Question 12

deferred charges

Answer 12

A disappearing term describing items that have debit balances, such as deferred development costs, pre-operating and start-up costs, and organization costs. These are no longer considered to have future economic benefit and therefore, are generally expensed as incurred

Question 13

Development

Answer 13

The translation of research findings or other knowledge into a plan or design for new or substantially improved materials, devices, products, processes, systems, or services prior to the commencement of commercial production or use

Question 14

development phase

Answer 14

A broad category of development activities where costs are capitalized only when future benefits are reasonably certain

Question 15

discounted free cash flow method

Answer 15

A method to value goodwill that involves a projection of the company’s free cash flow over a long period

Question 16

economic benefits

Answer 16

Benefits provided by assets such as revenues from sales of products or services, reductions in future costs, etc.

Question 17

excess-earnings approach

Answer 17

A method used to value goodwill that calculates the “normal” earnings generated by firms in the same industry. If a business earns a higher rate of return than the industry average, this excess is goodwill

Question 18

favourable lease

Answer 18

A lease that is considered an intangible asset when the terms are more favourable than the usual market terms

Question 19

franchise

Answer 19

A contractual arrangement under which the franchisor grants the franchisee the right to sell certain services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area. (Synonym: licensing agreements)

Question 20

Goodwill

Answer 20

When an investor acquires an investment at a price that is more than the investee’s underlying book value

Question 21

identifiable

Answer 21

A quality of intangible assets that either results from contractual or other legal rights, or can be separated and divided from the entity and sold, transferred, licensed, rented, or exchanged, either by itself or with another contract, identifiable asset, or liability

Question 22

identifiable net assets

Answer 22

Arise when the purchase price is allocated among all the assets and liabilities to which a value can be attributed and refers to all net assets except goodwill

Question 23

impaired

Answer 23

When the carrying amount of a long-lived asset is higher than its future economic benefits to the company

Question 24

in-process research and development (R&D)

Answer 24

An identifiable intangible asset involving the research work and findings of a company, acquired when company purchases another. It must be separable from goodwill

Question 25

indefinite life

Answer 25

There appears to be no foreseeable limit to how long the asset will generate cash flows to the entity

Question 26

indefinite-life

Answer 26

This method does not change the inventory cost amount, but establishes a separate contra asset account and a loss account to record the write-off. (Synonym: allowance method)

Question 27

intangible assets

Answer 27

Assets that lack physical substance and usually have a higher degree of uncertainty concerning their future benefits

Question 28

intellectual capital

Answer 28

Internally developed intangible assets, such as key personnel. (Synonym: Knowledge assets)

Question 29

knowledge assets

Answer 29

Unrecognized intangible assets related to the creativity and knowledge of key employees that create value for a company. (Synonym: intellectual capital)

Question 30

lease

Answer 30

A contractual agreement between a lessor and a lessee that gives the lessee the right to use specific property, owned by the lessor, for a specified time in return for stipulated, and generally periodic, cash payments (rents).

Question 31

leasehold

Answer 31

A contractual understanding between a lessor (property owner) and a lessee (property renter) that grants the lessee the right to use a specified property owned by the lessor for a specific period of time in return for stipulated and generally periodic cash payments

Question 32

licences

Answer 32

Operating rights obtained through agreements with governmental units or agencies, such as the use of airwaves for radio or television broadcasting

Question 33

Licensing agreements

Answer 33

Contractual arrangements under which the franchisor grants the franchisee the right to sell certain services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area. (Synonym: franchise)

Question 34

Marketing-related intangible assets

Answer 34

Are those intangible assets related primarily to the marketing or promotion of products or services.

Question 35

monetary assets

Answer 35

Money or claims to future cash flows that are fixed in amounts and timing by contract or other arrangement

Question 36

negative goodwill

Answer 36

When an investor acquires an investment at a price that is less than the investee’s underlying book value

Question 37

normalized earnings

Answer 37

Adjusted past earnings in order to estimate expected future earnings

Question 38

number of years method

Answer 38

A method of valuing goodwill where the excess earnings are multiplied by the number of years they are expected to continue

Question 39

organization costs

Answer 39

Costs incurred in the formation of a corporation

Question 40

patent

Answer 40

A right to use, manufacture, and sell a product or process for a period of twenty years from the date of application without influence or infringement by others

Question 41

permits

Answer 41

Operating rights obtained through agreements with governmental units or agencies. (Synonym: licence)

Question 42

prepaid expense

Answer 42

Expenses paid in cash and recorded as assets before they are used or consumed

Question 43

rational entity impairment model

Answer 43

This approach assumes that an entity makes rational decisions in managing its long-term assets and therefore it compares the asset’s book value with a recoverable amount that differs depending on the circumstances

Question 44

Research

Answer 44

A planned investigation undertaken with the hope of gaining new scientific or technical knowledge and understanding

Question 45

research phase

Answer 45

A broad category of research activities where costs are recognized as expenses when they are incurred

Question 46

Technology-based intangible assets

Answer 46

Relate to innovations or technological advances such as patented technology and trade secrets

Question 47

total-earnings approach

Answer 47

A method of valuing goodwill where the value of the company as a whole is determined based on the total expected earnings, not just the excess earnings

Question 48

trade name

Answer 48

One or more words, or a series of letters or numbers, or a design or shape that distinguishes a particular enterprise or product

Question 49

trademark

Answer 49

One or more words, or a series of letters or numbers, or a design or shape that distinguishes a particular enterprise or product

Question 50

Define and describe the characteristics of intangible assets

Answer 50

Intangible assets have three characteristics: (1) they are identifiable; (2) they lack physical substance; and (3) they are non-monetary in nature

Question 51

Identify and apply the recognition and measurement requirements for purchased intangible assets

Answer 51

A purchased intangible asset is recognized when it is probable that the entity will receive the expected future economic benefits and when its cost can be measured reliably. It is measured initially at cost. When several intangibles, or a combination of intangibles and other assets, are acquired in a business combination, the cost of each intangible asset is its fair value. When acquired in a business combination, the identifiable intangibles are recognized separately from the goodwill component

Question 52

Identify and apply the recognition and measurement requirements for internally developed intangible assets

Answer 52

No costs are capitalized unless they meet the general recognition criteria concerning future benefits and measurability. Costs incurred in the research phase of developing an intangible asset internally are expensed. Costs incurred in the development phase of a project are also expensed unless the entity can demonstrate that it meets six stringent criteria. These criteria are designed to provide evidence that the asset is technically and financially feasible and that the company has the intent and ability to generate future economic benefits from it. Under private entity GAAP, entities have a choice whether to capitalize or expense costs that meet the six criteria

Question 53

Explain how intangible assets are accounted for after initial recognition

Answer 53

Under private entity GAAP, intangible assets are accounted for using the cost model, whereas IFRS also allows the revaluation model to be used if the asset’s fair value is determined in an active market. This is not often used. An intangible with a finite or limited useful life is amortized over its useful life to the entity. Except in unusual and specific circumstances, the residual value is assumed to be zero. The amount to report for amortization expense should reflect the pattern in which the asset is consumed or used up if that pattern can be reliably determined. Otherwise a straight-line approach is used. An intangible with an indefinite life is not amortized until its life is determined to no longer be indefinite. All intangibles are tested for impairment

Question 54

Identify and explain the accounting for specific types of intangible assets

Answer 54

Major types of intangibles include the following: (1) marketing-related intangibles that are used in the marketing or promotion of products or services; (2) customer-related intangibles that are a result of interactions with outside parties; (3) artistic-related intangibles that involve ownership rights to such items as plays and literary works; (4) contract-related intangibles that represent the value of rights that arise from contractual arrangements; and (5) technology-related intangible assets that relate to innovations or technological advances

Question 55

Explain and account for impairments of limited-life and indefinite-life intangible assets

Answer 55

Under private entity GAAP, impairment is determined and applied by using the cost recovery impairment model. Impairment for limited-life intangible assets is based first on a recoverability test. If the carrying amount is higher than its net recoverable amount (undiscounted), then an impairment loss must be measured and recognized, based on the asset’s fair value. No reversals of such losses are permitted. The procedures are the same as for property, plant, and equipment. Indefinite-life intangibles use only a fair value test. Under IFRS, the rational entity impairment model is used. An intangible asset is impaired only if its carrying amount is higher than its recoverable amount. The recoverable amount is defined as the greater of the asset’s value in use and its fair value less costs to sell. The impairment loss is the difference between the carrying amount and the recoverable amount, if lower. The loss is reversed subsequently if economic conditions change and the recoverable amount increases. The same approach is used for both limited-life and indefinite-life intangible assets

Question 56

Explain the concept of goodwill and how it is measured and accounted for after acquisition

Answer 56

Goodwill is unique because, unlike all other assets, it can be identified only with the business as a whole. It is not an identifiable asset. Goodwill is recorded only when a business is purchased. To calculate goodwill in a 100% acquisition, the fair value of the identifiable assets that are acquired and liabilities that are assumed is compared with the fair value of the consideration transferred for the acquired business. The difference is goodwill. After acquisition, it is not amortized but is regularly assessed for impairment. The goodwill has to be assigned to a cash-generating group or reporting unit and the group is tested for impairment. Under private entity GAAP, a goodwill impairment loss is recognized if the fair value of the asset group is lower than the group’s carrying amount, and the loss is equal to the difference. Under IFRS, there is a goodwill impairment loss if the recoverable amount of the cash-generating unit is less than its carrying amount. The loss is equal to the difference and is applied to goodwill first. Under both, goodwill impairment losses are not reversed.

Question 57

Identify the types of disclosure requirements for intangible assets and goodwill and explain the issues in analyzing these assets

Answer 57

Disclosures under private entity GAAP are limited because users can access additional information. Under IFRS, significant details are required to be disclosed. The disclosures allow a reader to determine how amounts invested in classes of intangibles (and goodwill) have changed over the period, with substantial information provided when fair values are used, such as under the revaluation model and all impairment calculations. For intangibles that are not amortized, companies must indicate the amount of any impairment losses that have been recognized as well as information about the circumstances that led to the writedown. Goodwill must be separately reported, as are the major classes of intangible assets. Because it is difficult to measure intangibles, some resources, such as intellectual capital and other internally developed intangible assets, do not get captured on the balance sheet. Other intangibles are recognized, but with a relatively high level of measurement uncertainty. For these reasons and because of recent changes in the accounting policy related to intangibles, care must be taken in the analysis of financial statement information related to earnings and total assets.

Question 58

Identify differences in accounting between private entity GAAP and IFRS

Answer 58

There are few, but significant, differences between private entity GAAP and IFRS regarding intangible assets and goodwill. One major difference relates to the accounting treatment for costs incurred in the development phase of internally generated intangible assets that meet the six stringent criteria for capitalization. Under private entity GAAP, entities can choose a policy of whether to capitalize these costs or expense all costs associated with internally generated intangibles. Under IFRS, these costs are capitalized. The other major difference relates to the impairment models applied: the cost recovery model for private entity GAAP, and the rational entity model for IFRS

Question 59

Explain and apply basic approaches to valuing goodwill

Answer 59

One method of valuing goodwill is the excess-earnings approach. Using this approach, the value of goodwill is based on discounting expected future earnings in excess of the industry average to their present value. Another method involves determining the total value of the business by capitalizing total earnings, and then deducting the fair values of the identifiable net assets. The number of years method of valuing goodwill simply multiplies the excess earnings by the number of years of expected excess earnings. Another method of valuing goodwill is the discounted free cash flow method, which projects the future operating cash that will be generated over and above the amount needed to maintain current operating levels. The present value of the free cash flows is today’s estimate of the firm’s value.