423449563 Audit of Prepayment and Intangible Asset PDF

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AUDIT OFPREPAYMENT ANDINTANGIBLEASSETPROBLEM 6-The INTANGIBLES COMPANY engaged in the following transactions at the beginning of2018: Purchased a patent for P700,000 that had originally been filed in January 2012. The acquisition was made to protect another patent that the company had filed for in J...

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AUDIT OF PREPAYMENT AND INTANGIBLE ASSET PROBLEM 6-1 The INTANGIBLES COMPANY engaged in the following transactions at the beginning of 2018: 1. Purchased a patent for P700,000 that had originally been filed in January 2012. The acquisition was made to protect another patent that the company had filed for in January 2014 and subsequently received. 2. Purchased the rights to a novel by a best-selling novelist in exchange for 100,000 ordinary shares (P10 par) selling for P60 per share. The book sells 1 million copies in 2018 and is expected to sell a total of 500,000 copies in future years. 3. purchased the franchise to operate a ferry service from the government for P100,000. A bridge has been planned to replace the ferry, and it is expected that it will be completed in five years. The company hopes that the ferry will continue as a tourist attraction, but profits are expected to be only 20% of those earned before the bridge is opened. 4. paid P280,000 to attorneys for the services to successfully defend the patent acquired in transaction 1.

5. Paid a taxi operator P500,000 to have the company name prominently displayed on his taxis for two years. Based on the preceding information, determine the carrying value of the following at the end of 2018: 1. Patent A. P630,000 B. P656,250

C. P910,000 D. P650,000

2. Copyright A. P2,000,000 B. P0

C. P3,000,000 D. P4,000,000

3. Franchise A. P100,000 B. P84,000

C. P80,000 D. P76,000

SOLUTION 6-1 1. Cost of patent Amortization for 2018 (p700,000/14 years) Carrying value, December 31, 2018 Answer: D

P700,000 (50,000) P650,000

The competing patent purchased to protect another patent with a life of 16 years has a remaining legal life of 14 years and should be amortized over that period 2. cost of copyright Amortization for 2018 (6,000,000 x 1 milllion/1.5 million) Carrying value, December 31, 2018 Answer: A

P6,000,000

3. Cost of franchise Amortization for 2018 (P100,000/5) Carrying value, December 31, 2018 Answer: C

P100,000 (20,000) P80,000

(4,000,000) P2,000,000

PROBLEM 6-2 The following independent situations relate to the audit of intangible assets. Answer the question/s at the end of each situation.

Situation 1 YOLING INDUSTRIES reports the following patents on its December 31, 2017, statement of financial position.

Patent A Patent B Patent C

Initial cost

Date of acquisition

P1,224,000 450,000 432,000

March 1, 2014 July 1, 2015 Sept. 1, 2016

Useful life (at the date of acquisition) 17 years 10 years 4 years

The following events occurred during the year ended December 31, 2018. 1. Research and development costs of P737,100 were incurred during the year. These costs were incurred prior to projects achieving economic viability. 2. Patent D was purchased on july 1 for P855,000. It has a remaining life of 91/2 years. 3. A possible impairment of Patent B’s value may have occurred at December 31, 2018. This is due to a significant reduction in the demands for certain products protected by Patent B. The company’s controller estimates the following future cash flows from Patent B. December 31, 2019 P60,000 December 31, 2020 P60,000 December 31, 2021 P60,000

The appropriate discount rate to be used for these cash flows is 8%. 1. What is the total carrying value of Yoling’s Patents on December 31, 2017? A. P2,383,500 C. P2,106,000 B. P1,390,620 D. P1,573,500

2. What amount of impairment loss should be reported by Yolling for the year ended December 31, 2018? A. P137,880 C. P337,500 B. P292,500 D. P154,620 3. What is the total carrying value of Yolling’s patents on December 31,2018? A. P1,969,080 C. P2,158,500 B. P2,020,620 D. P2,203,500 SITUATION 2

In your audit of the books of DIEHARD CORP. for the year ended December 31, 2018, you found the following items in connection with the company’s patents account. a) Diehard had spent P360,000 during the year ended December 31, 2017, for research and development costs. This amount was debited to its patents account. The company’s cost records disclose that it had spent a total of P424,500 for the research and development of its patents, of which P64,500 spent in 2017 had been debited to Research And Development Expense. b) The patents were issued on July 1, 2017. In connection with the issuance of the patents, the company incurred legal expenses of P42,840, which debited to Legal And Professional Fess Expense. c) On January 5, 2018, Diehard paid a retainer of P45,000 for legal services in connection with a patent infringement suit brought against it. Deferred costs was charged for the amount. d) In reply to your inquiry about the company’s liabilities as of December 31, 2018, you received a letter from the company’s legal counsel dated January 20, 2019, which indicated that a settlement of the patent infringement suit had been arranged. The plaintiff will drop the suit and release the company from all future liabilities in exchange for P60,000. Additional lawyer’s fees were incurred amounting to P3780. 4. The correcting journal entries (excluding amortization) on December 31, 2018, wpould include net debit (credit) to A B C D

Patents P(317,160) (208,380) (272,160) (253,380)

Legal and professional fess expense P108,780 0 63,780 45,000

SITUATION 3 As the recently appointed auditor for SUPERPOWER COMPANY, you have been asked to examine selected accounts. Your audit client, organized in 2017, has setup a single account for all intangible assets. The following summary shows the debit entries that have been recorded during 2018.

jan. 2 April 5 June 30 July 1 Aug. 3 Sept. 1

Purchased patent (8-year life) Goodwill Payment of 12 months’ rent on property leased by superpower Purchased franchise with 10-year life; expiration date, july 1, 2028 Payment for copyright (5-yearlife0 Research and development costs related to patent (incurred prior to achieving economic viability)

P 870,000 720,000 182,000 900,000 312,000 320,000 P 3,304,000

5. What is the total carrying value of superpower’s intangible assets as of December 31, 2018? A. P2,928,917 C. P2,927,705 B. P2,622,250 D. P2,713,250

SOLUTION 6-2 1. patent A Initial cost Amortization: 2014 (P1,224,000/17 x 10/12) P60,000 2015-2017 (p1,224,000 x 3/17) 216,000 patent B Initial cost Amortization: 2014 (P1,224,000/17 x 10/12) P22,500 2015-2017 (p1,224,000 x 3/17) 90,000 patent C Initial cost Amortization: 2014 (P1,224,000/17 x 10/12) P36,000 2015-2017 (p1,224,000 x 3/17) 108,000 Total carrying value of patents, Dec. 31, 2017

P1,224,000

(276,000)

P948,000

P450,000

(112,500)

P337,500

P432,000

(144,000)

P288,000 P1,573,500

ANSWER: D

2. Patent B Carrying value, December 31, 2017 P337,500 Less: 2018 amortization (P450,000 x 1/10) 45,000 Carrying value, December 31, 2018 292,500 Present value of future cash flows (P60,000 X 2,5770) 154,620 Impairment loss P137,880 ANSWER: A

3. patent A Carrying value, December 31, 2017 P948,000 Less: 2018 amortization (P1,224,000x1/17) 72,000 P876,000 Patent B 154,620 Patent C Carrying value, \december 31, 2017 P288,000 Less: 2018 amortization (P432,000 x ¼) 108,000 180,000 Patent D Initial cost P855,000 Less: 2018 amortization (P855,000/9.5 x 6/12) 45,000 810,000 Total carrying value of patents, December 31, 2018 P2,020,620 ANSWER: B SITUATION 2 4. Adjusting Journal Entries December 31, 2018 a) Retained earnings patents

360,000

b) Patents retained earnings

42,840

c) Legal and professional fees expense deferred costs

45,000

d) Legal and professional fees expense liability for settlement of patent infringement suit accrued attorney’s fees ANSWER: A

63,780

360,000

42,840

45,000

60,000 3,780

SITUATION 3 5. patent Less: Amortization (P870,00/8) Goodwill

P870,000 108,750

P 761,250 720,000

Franchise P900,000 Less: Amortization(P900,000/10 X 6/12) 45,000 Copyright P312,000 Less: Amortization(P312,000/5 x 5/12) 26,000 Total carrying value, December 31, 2018 ANSWER: B

855,000 286,000 P2,622,250

PROBLEM 6-3 The following situations are found in the records of the KILIMANJARO, INC. in your audit of the company’s financial statements for the year ended December 31, 2018. 1. December 1, 2018: Advertising expense 72,000 Cash Payment of 2018 advertising contract.

72,000

2. Balance of Office supplies expense, Dec. 31, 2018 Balance of unused office supplies, Dec. 31, 2018 Inventory of office supplies, Dec. 31, 2018

P45,000 15,000 22,500

3. June 2, 2018 Prepaid insurance 54,000 Cash 54,000 Payment of one-year insurance premium for inventory. 4. Balance of factory supplies expense account, Dec. 31, 2018 Physical inventory of factory supplies, Dec. 31, 2018

P69,000 58,500

5. On May 1, 2018, a two-year subscription to the industry journal in the amount of P14,400 was paid. Subscription expense was charged for the entire amount. Prepare the adjusting journal entries on December 31, 2018, based on the situations described.

SOLUTION 6-3 ADJUSTING JOURNAL ENTRIES December 31, 2018

1. Prepaid advertising Advertising expense

72,000 72,000

2. Unused office supplies Office supplies expense (P22,500 – P15,000)

7,500

3. Insurance expense Prepaid insurance (P54,000 X 7/12)

31,500

4. Factory supplies inventory Factory supplies expense

58,500

5. Prepaid subscriptions Subscription expense (P14,400 X 16/24)

7,500

31,500

58,500 9,600 9,600

PROBLEM 6-4 KENYA ENTERPRISE developed a new machine that reduces the time required to mix the chemicals used in one of its leading products. Because the process is considered very valuable to the company, Kenya patented the machine. Kenya incurred the following expenses in developing and patenting the machine: Research and development laboratory expenses Materials used in the construction of the machine Blueprints used in the construction of the machine Legal expenses to obtain patent Wages paid for the employees’ work on the research, development, and building of the machine (60% of the time was spent in actually building the machine) Expense of drawing required by the patent office to be submitted with the patent application Fees paid to Patent Office to process application

P750,000 240,000 96,000 360,000

900,000 51,000 75,000

One year later, Kenya Enterprises paid P525,000 in legal fees to successfully defend a patent against an infringement suit by Gaya-gaya Company. 1. What is the total cost of the patent? A. P993,000 C. P564,000

B. P486,000

D. P126,000

2. What is the total cost of the new machine? A. P1,362,000 C. P780,000 B. P0 D. P876,000 3. What is the entry to record the legal fees paid for the successful defense of the patent against the infringement suit? A. Patents 525,000 Cash 525,000 B. Legal fees expense 525,000 Cash 525,000 C. Machinery 525,000 Cash 525,000 B. Amortization expense - patents 525,000 Cash 525,000

SOLUTION 6-4 1. Legal expenses to obtain patent Expense of drawing required by patent office to be submitted with patent application Fees to be paid to process patent application Total cost of patent ANSWER: B

P360,000 51,000 75,000 P486,000

2. Materials used in the construction of the machine Blueprints used to design the machine Wages of the employees’ work on the construction of the machine (P900,000 x 60%) Total cost of machine ANSWER: B

P240,000 96,000 540,000 P486,000

3. The legal fees paid for the successful defense of the patent should be expensed, not capitalized. This expenditure does not meet the definition of and the recognition criteria for an intangible asset. The entry to record the legal fees paid is: Legal fees expense Cash ANSWER: B

PROBLEM 6-5

525,000 525,000

Identifying Intangible Assets

The following amounts are included in the general ledger of MARGHERITA PEAK CORPORATION at December 31, 2018:

Organization costs

P 72,000

Trademarks

45,000

Patents

225,000

Discount on bonds payable

105,000

Deposits with advertising agency for ads to promote goodwill of company

30,000

Cost of equipment acquired for various research and development projects

320,000

Costs of developing a secret formula for a product that is expected to be marketed for at least 20 years

240,000

On the basis of the information above, what is the total amount of intangible assets to be reported by Margherita Peak in its statement of financial position at December 31, 2018? A. P342,000 B. P270,000

C. P510,000 D. P830,000

SOLUTION 6-5 Trademarks

P 45,000

Patents

225,000

Total intangible assets

270,000

Answer: B   

Organization cost should be recognized as expense in the period it is incurred. Discount on bonds payable should be reported as a contra account to bonds payable. Cost of equipment acquired for various research and development projects should be included in the property, plant, and equipment section.



Deposits with advertising agency for ads to promote goodwill of the company should be reported as prepaid advertising in the current assets section. PAS 38 does not preclude recognizing a prepayment as an asset when payment for the delivery of goods or rendering of the services.

PROBLEM 6-6

Patent

As a member of the audit team for the audit of RAS DASHEN COMPANY’s financial statements for the year ended December 31, 2018, you have been asked to examine selected accounts. The controller for Ras Dashen mentions that there is only one account (shown below) kept for intangible assets.

INTANGIBLE ASSETS Debit P72,000

Credit

Balance

Feb. 1

Organization costs

P72,000

Mar. 15

Research and development

1,880,000

1,952,000

April 3

Legal costs to obtain patent

150,000

2,102,000

May 1

Payment on 12 months’ rent

240,000

2,342,000

414,000

2,756,000

on bonds due Dec. 31, 2038

168,000

2,924,000

Operating losses for first year

482,000

3,406,000

on property leased by Ras Dashen June 15

Promotional expenses related to start-up of business

Dec. 31

Dec. 31

Unamortized bond discount

1. The amount of organization expenses to be reports in Ras Dashen’s income statement for the year ended December 31, 2018 is A. P2,348,000 C. P582,000 B. P486,000 D. P240,000

2. What is the carrying value of the patent at December 31, 2018 assuming that its useful life is 10 years? A. P150,000 C. P135,000 B. P138,750 D. P0 3. The prepaid rent to be shown on Ras Dashen’s statement of financial position at December 31, 2018, is A. P160,000 C. P80,000 B. P240,000 D. P0

SOLUTION 6-6 1. Organizational costs Promotional expenses related to start-up of business Total organization expenses

P 72,000 414,000 P486,000

Answer: B 2. Legal cost to obtain patent Less: Amortization, April 3 – Dec. 31 (150,000/10 x 9/12) Balance, Dec. 31, 2018

P150,000 11,250 P138,750

Answer: B 3. Prepaid rent, Dec. 31, 2018 (P240,000 x 4*/12) *Jan. 1, 2019 – May 1, 2019

P 80,000

Answer: C

PROBLEM 6-7

Lease Bonus and Leasehold Improvements

MERU, INC. leases an old building which it intends to improve and use for administrative purposes. The company pays a bonus of P100,000 to obtain the lease. Annual rental for the 10year lease period is P160,000. No option to renew the lease or right to purchase the property is given by the lessor. After obtaining the lease, improvements on the leased building are made costing P400,000. The building has an estimated remaining useful life of 19 years.

1. What is the annual cot (excluding depreciation) of this lease to Meru, Inc.?

A. P210,000 B. P200,000

C. P160,000 D. P170,000

2. What is the amount of annual depreciation (straight-line), if any, should Meru, Inc. record? A. P40,000 C. P50,000 B. P30,000 D. P0 3. What is the entry to record the lease bonus paid at the inception of the lease? A. Rent expense 100,000 Cash 100,000 B. Prepaid rent 100,000 Cash 100,000 C. Prepaid rent 90,000 Rent expense 10,000 Cash 100,000 D. Rent expense 90,000 Prepaid expense 10,000 Cash 100,000

SOLUTION 6-7 1. Annual Rental Amortization of lease bonus Annual cost of lease

P160,000 10,000 P170,000

Answer: D 2. Annual depreciation on leasehold improvements (400,000/10 years)

P40,000

Answer: A 3. Prepaid Rent Cash

100,000 100,000 Answer: B

PROBLEM 6-8

Organizational Costs

ELGON COMPANY was organized in 2017 and began operations at the beginning of 2018. The company provides landscaping services. The following costs were incurred prior to the start of operations: Legal fees in connection with organization of the company

P171,000

Improvements to leased office space prior to the occupancy

225,000

Costs of meetings of incorporators to discuss organizational activities

63,000

Filing fee to incorporate

9,000 P468,000

What is the total amount of organization costs that should be reported in Elgon’s income statement? A. P243,000 B. P468,000

C. P180,000 D. P207,000

SOLUTION 6-8

Legal fees in connection with organization of the company

P171,000

Costs of meetings of incorporators to discuss organizational activities Filing fee to incorporate

63,000 9,000 P243,000

Answer: A Improvements to leased office space prior to occupancy of P225,000 should be classified as leasehold improvements.

PROBLEM 6-9

Accounting for Patent, Franchise, R&D Costs

CAMEROON CORP. has provided information on intangible assets as follows:







A patent was purchased from Patintero Company for P6,000,000 on January 1, 2017. On the acquisition date, the patent was estimated to have a useful life of 10 years. The patent had a net book value of P6,000,000 when Patitero sold it to Cameroon. On February 1, 2018, a franchise was purchased from the Franchisor Company for P1,440,000. The contract which runs for 20 years provides that 5% of revenue from the franchise must be paid to Franchisor. Revenue from the franchise for 2018 was P7,500,000. The following research and development costs were incurred by Cameroon in 2018: Materials and equipment

P

426,000

Personnel

567,000

Indirect costs

306,000

Total

P1,299,000

Because of recent events, Cameroon, on January 1, 2018, estimates that the remaining useful life of the paten...