Chapter 14

CHAPTER
14
14-1.
SUBSTANTIVE TESTS OF
INTANGIBLE ASSETS
The decision whether a given expenditure on intangible asset to be treated as

expense or asset requires judgment. Expenditure giving rise to future benefits will
be classified as assets while those expenditure the future benefits from which are
uncertain are charged of as expense in the year incurred. The expected benefit
from the intangible assets can be assessed in terms of the following:
a) Patents: Actual production of the goods covered by the patent
b) Goodwill: Review of actual excess income as well as actual income of the
investee
c) Trademark / Tradename: Continuous production of the product covered by
the trademark/tradename.
14-2.
Research and Development Costs vary widely among companies. Many

expenditures do have future worth, while others are so highly uncertain as to
future value that recording them as assets is clearly improper.
The auditors interest in auditing Research and Development costs stems from the
objective of determining whether they should be deferred or charged against
current operations. He shall be guided by GAAP in judging whether the clients
treatment of the Research and Development Costs is justified or not.
14-3.
Menfro, Inc.
The rapid amortization of the leasehold for the first twelve (12) years resulted to
an understatement of income totaling to P60,000:
Correct amortization P450,000 x 12
20
Amortization per client (P27,500 x 12)
P270,000
Over-amortization
P 60,000
330,000
In view of the above, the amount of P60,000 should be added back to Retained
Earnings as correction of prior years profits. Furthermore, amortization of
P22,500 for the 13th year should be recorded.
These adjustments would result to a net increase in the Retained Earnings balance
which will enable the company to declare dividends without depleting the
Retained Earnings balance significantly.
14-2
Applied Auditing 2014 Edition Solutions Manual
14-4.
Requirement (a)
The annual depreciation for years 11 to 25 is P1,667. By the end of the 25th year,
the building would be fully depreciated. [(50,000 25,000) / 15 years)
Requirement (b)
If the original lease had contained a renewal clause for an additional 20 years, the
depreciation rate would still be 5%, which is based on the original term of the
lease. The renewal of the lease contract is not certain and therefore will not be
considered in the determination of the amortization period.
14-5.
Process Development Company

Process Development Company
Patents Amortization Schedule
Description
Patent
P
Q
R
Cost as
Recorded
P 40,000
120,000
160,000
P320,000
Less: Adjustment
as per BIR
requirement
80,000
As Adjusted
P240,000
2015
P1,212.12
3,529.41
4,705.88
P9,447.41
(2,361.85)
P7,085.56
(a)
Amortization Per Client

2006 to 2014
Total
Adjustment
P 19,393.94
P 20,606.06 P(5,151.52)
56,470.59
60,000.00
(15,000)
75,294.12
80,000.00
(20,000)
P151,158.65
P160,606.06
As Adjusted
P 15,454.54
45,000.00
60,000.00
(37,789.67)
P113,368.98
(b)
P120,454.54
* Based on 17 years legal life.

(a) 2006 Amortization:
P =
30,000
16.5
x 0.5 = P 909.09
Q&R =
210,000
17
x 0.5 =
6,176.47
P7,085.56
(b) 2007 to 2014 Amortization:

P =
30,000
16.5
Q&R =
210,000
17
x 8
=P 14,545.45
x 0.5 = 98,823.53
P113,368.98
(40,151.52)
P120,454.54
Substantive Tests of Intangible Assets
14-3
Adjusting Journal Entries

(1)
(2)
14-6.
Capital in excess of par value

Patent P
Patent Q
Patent R
To adjust patent valuation to conform
to BIR requirement.
80,000.00
Accumulated amortization Patent P

Accumulated amortization Patent Q
Accumulated amortization Patent R
Retained earnings Correction of prior
years profit
To adjust amortization provision from
2006 to 2014.
5,151.52
15,000.00
20,000.00
10,000.00
30,000.00
40,000.00
40,151.52
Cartwright Corporation
Note to Instructor: For ease of discussion, the adjusting entries in the solution are
dated to correspond with the original erroneous journal entries. In actual practice,
they would be dated as of the year-end.
Jan. 1
10
Apr. 1
May 15
Organization Expenses
Intangibles
To classify incorporation fees.
17,500
Organization Expenses
Intangibles
To classify legal fees for the
organization of the company.
7,500
Advertising Expense
Intangibles
To expense advertising costs.
15,000
Land
Building
Intangibles
To reclassify land and buildings for
R & D activities.
15,000
20,000
Research and Development Expenses

Intangibles
To expense materials purchased.
15,000*
* Alternatively, unused materials and

supplies, if material, may be set up as
prepaid expenses.
17,500
7,500
15,000
35,000
15,000
14-4

June 30
July 1
Dec. 10
31
31
31
Patent
Intangibles
To reclassify the patent.
10,000
Income Summary / Retained Earnings

Intangibles
To record operating loss.
12,000

Intangibles
To record acquisition of equipment.
12,000

Intangibles
To expense R & D costs.
30,000
10,000
12,000
12,000
30,000

Accumulated Depreciation: Building
To record year depreciation on R
& D building (20-year life) from
April 1 entry.
750
Amortization Expense
Patent
To record year amortization (20year life) on June 30 patent.
250
750
250
PAS 38 prohibits capitalization of start-up expenses such as organization costs.

No amortization should therefore be recorded.
14-7.
Harper, Inc.
Calculation of Goodwill
Average year-end net assets:
(P2,400,000 5)
Average annual earnings
(P400,000 5)
Less: Normal return on average year-end assets
(10% x P480,000)
Excess annual earnings
Excess annual earnings capitalized at 20% or Goodwill
P32,000 12%
P 480,000
P 80,000
48,000
P 32,000
= P160,000

14-8.
14-5
Bayer, Inc.
Net tangible assets per records, Nov. 1, 2015

Add: Agreed increase in value of equipment
Net adjusted tangible assets
Add: Value of Goodwill (Schedules 1 & 2)
Total amount to be paid for net tangible assets
and goodwill
Bayer, Inc.
P328,500
40,000
P368,500
74,900
Lead, Inc.
P298,500
P443,400
P311,400
P298,500
12,900
Supporting Computations:
Schedule 1: Goodwill of Bayer, Inc.
Average pre-tax earnings 11.1.10 to 11.1.15
Less:
Additional annual depreciation equipment taken over
at P40,000 in excess of book value (P40,000 / 5)
Adjusted pre-tax earnings
Less:
Required earnings on net tangible assets
(15% x P368,500)
P82,000
Excess annual pre-tax earnings
P18,725
Goodwill (excess earnings capitalized at 25%)
P74,900
8,000
P74,000
55,275
Schedule 2: Goodwill of Lead, Inc.
14-9.
Average pre-tax earnings 11.1.10 to 11.1.15

Less:
Adjustment for effect of organization cost written off
in 2014 (P20,000 / 5)
Adjusted pre-tax earnings
Less:
Required earnings on net tangible assets
(15% x P298,500)
P44,000
Excess annual pre-tax earnings
P 3,225
Goodwill (excess earnings capitalized at 25%)
P12,900
4,000
P48,000
44,775
Phoenix Supply Company

Requirement (a)
Allocation of the P137,500 cost to the individual assets in the group of assets
acquired is based on the relative fair value of the individual assets.
14-6

Asset
Patent A
Patent B
Equipment
Land
Appraisal
Value
Portion of
Total Value
P 30,000
40,000
19,700
62,000
30/151.7
40/151.7
19.7/151.7
62/151.7
Total
Cost
x
x
x
x
P137,500
137,500
137,500
137,500
P151,700
Allocated
Cost
=
=
=
=
P 27,192
36,256
17,856
56,196
P137,500
Journal entries for 2013, 2014 and 2015, relative to intangible assets, are as
follows:
2013
Apr. 27 Patent A
Patent B
Equipment
Land
Cash
To record the acquisition of assets.
27,192
36,256
17,856
56,196
Oct. 31 Amortization of Patents

Patent A (27,192 / 5 x 6/12)
Patent B (36,256 / 12 x 6/12)
To record amortization of patents
for 2004.
4,230
137,500
2,719
1,511
2014
Mar. 7 Legal Expenses
17,600
Cash
To record legal fees related to defense
of patents.
Mar. 7 Amortization of Patents
Patent A
To record amortization on Patent A
to date of write-off (Nov. 2013 to
Feb. 2014).
17,600
1,813
Mar. 7 Loss on Patent A

22,660
Patent A
To record write-off of Patent A after
unsuccessful defense.
1,813
22,660

3,021
Patent B
To record amortization of Patent B for 2014.
14-7
3,021
2015
3,021
Patent B
To record amortization on Patent B for 2015.
3,021
Computations
Amortization for 2015:
Patent A: (P27,192 / 5 years) (6 / 12)
Patent B: (P36,256 / 12 years) (6 / 12)
Amortization on Patent A, 10/31/2013 3/7/2014:
(P27,192 / 5 years) (4/12)
Book value of Patent A to 3/7/2014:
Cost
Amortization recognized
P2,719
1,813
Amortization for 2014 and 2015:

Patent B: (P36,256/12 years)
P 2,719
1,511
P 4,230
P 1,813
P27,192
4,532
P22,660
P 3,021
The cost basis of patent B is P36,256 - P1,511 + P8,800 - P3,546). 2014, a full
years amortization is taken by dividing the unamortized cost by the remaining
useful life. In 2015 this is P39,999/10 years or P3,809.
Requirement (b)
The legal costs of a court defense should be charged to expense whether the suit is
won or lost because it does not meet the recognition criteria. Also, the
unsuccessful defense implies that Patent A is of no further value to the company
and leads to the write-off of the remaining unamortized cost of that patent.
14-8
14-10.
Balagtas Enterprises
Requirement (a)
Patents
1. Balance before adjustment, 12/31/15
P550,000
Correction: Deduct unamortized balance of P75,000
expenditures incorrectly debited to account on 1/1/03:
P75,000 x (7 years/10 years)
(52,500) [AJE (1)]
Corrected balance before 2015 amortization
P497,500
2.
2015 Amortization
Patent having two years remaining life
Unamortized cost: P210,000 x (7 years/14 years)
= P105,000
Amortization: P105,000/2
Remaining Patents
Unamortized cost: P497,500 - P105,000 = P392,500
Amortization: P392,500/7
Franchise Agreement
Correction: Deduct periodic payment charged to account
Corrected balance before 2015 amortization
2.
2015 Amortization:
P50,000 / 5 years
Organization Costs
Correction: Legal fees incorrectly charged to
Goodwill account in 2007
Amortization of above costs,
1998 - 2004 (P45,000 / 40) (7 years)
2.
P 52,500
56,071
P108,571 [AJE (2)]
P 95,000
(45,000) [AJE (3)]
P 50,000
P 10,000 [AJE (4)]
P102,000
P45,000
[AJE (5)]
7,875
37,125 [AJE (6)]

P139,125 [AJE (7)]
No amortization need be taken up in 2015. With the effectivity of PAS 38

which does not allow deferment or capitalization of organization costs, the
entire balance of this account, should have been charged off against income in
2013. Adjusting entry in 2015 will be:
Retained earnings Prior period
adjustment
Organization costs
139,125
139,125

Goodwill
Correction: Reclassification of legal fees
to Organization Costs
Reclassification of advertising fee to Advertising Expense
Amortization on Goodwill for 2013
(P200,000 / 40 years)
Balance 12.31.13
2.
14-9
P345,000
( 45,000)
(100,000)
( 5,000)
P195,000
Effective January 2005, Revised PAS 36 prohibits amortization of intangibles

with indefinite life - Goodwill being one of them. Hence, no amortization
would be taken up starting 2005. Assessment for possible impairment should
be done annually or whenever there is an indication that the asset may be
impaired.
Adjusting Journal Entries:

Patents
AJE (1) Retained Earnings
Patents
52,500
AJE (2) Cost of Goods Sold

Patents
108,571
52,500
108,571
Franchise Agreement
AJE (3) Selling and Administrative Franchise Expense
Franchise Agreement
45,000
AJE (4) Selling and Administrative

Expense
Franchise Agreement
10,000
45,000
10,000
Organization Cost
AJE (5) Organization Costs
Goodwill
45,000
45,000

Organization Costs
7,875

Organization Costs
139,125
7,875
139,125
14-10

Goodwill
AJE (8) Selling and Administrative
Advertising Expense
Goodwill
100,000
100,000

Goodwill
5,000
5,000
Requirement (b)
(1) Retained Earnings
Selling and Administrative
Franchise Expense
Selling and Administrative
Advertising Expense
Organization Costs
Franchise Agreement
Goodwill
Patents
204,500
45,000
100,000
102,000
45,000
150,000
52,500
Summary:
Retained Earnings
AJE
(1)
(7)
(9)
(6)
(Dr.) Cr.
(52,500)
(139,125)
5,000
7,875
(204,500)
Organization Costs
AJE
(5)
(6)
(7)
Dr. (Cr.)
45,000
(7,875)
(139,125)
(102,000)
Goodwill
AJE
Dr. (Cr.)
45,000
100,000
5,000
150,000
(5)
(8)
(9)
(2) Cost of Goods Sold

Selling and Administrative Expense
Patents
Franchise Agreement
108,571
10,000
108,571
10,000

14-11.
14-11
Balagtas Company
Requirement (a)
The deficiencies listed below are apparent from the balance sheet and the
explanations given. The assumption is made that costs incurred have been
properly classified by Mr. Balagtas. The correct treatment of each item is
presented in the column on the right.
Deficiency
Correct Treatment
1.
Capitalization of expenses:
Research and development
Marketing research
Personnel recruitment and training
Legal fees relative to organization
of the corporation
Operating expenses
Treat all the items as expenses in

2015 income statement.
2.
No depreciation was taken on

machinery.
Expense appropriate amounts in the

2015 income statement.
3.
Ordinary shares account does not

reflect the par value of the
outstanding shares (11,000).
Increase ordinary shares by par

value of 1,000 shares.
4.
No statement of shareholders
equity and explanation of shares
issued is presented.
The statement should be provided,

including dates and numbers of
shares issued, peso amounts
assigned, and the bases for
assigning peso values in noncash
transactions. Also, land given by
Mario should be recorded at fair
value; services by Pedro should be
recognized as an expense at fair
value. Additional paid-in capital
may be recognized as the result of
the above.
5.
No accumulated deficit presented.
Deficit accumulated during

development stage should be
included in the shareholders equity
section. The amount results from
corrections made in items 1 and 2
above.
14-12

Requirement (b)
Additional items which should be included are:
14-12.
1.
Income statement, including amounts of revenue and expenses recognized

since the inception of the enterprise in 2015.
2.
Statement of cash flows, including cumulative amounts of sources and uses of

cash since the inception of the enterprise.
3.
Additional disclosures: identification of the company as a development-stage

enterprise, and description of significant development-stage activities.
Nikko Corporation
Requirement (a)
In a purchase transaction, assets are recorded at their acquisition price, which
becomes the cost basis to the acquiring corporation. The book values of the assets
for Rain Company are irrelevant.
Requirement (b)
When a price is paid for a group of assets, the total price must be allocated to the
individual assets. Because we know neither the total fair value of the tangible and
other intangible assets acquired from Rain Company nor the price to be paid by
the Nikko Corporation, we cannot determine whether Nikko Corporation has any
goodwill to record. The total price to be paid by the Nikko Corporation is
indefinite but it may be estimated by discounting the expected receipts (1% of net
sales) at the end of each of the next 5 years and adding the initial P450,000 cash
payment. If the estimated purchase price exceeds the sum of the estimated fair
values of the tangible and other assets purchased, then the excess may be recorded
as goodwill.
14-13.
Golden Springs Shopping Center, Inc.

Interest on mortgage bonds: An amount equal to the interest cost incurred in 2013
(P60,000) is clearly a cost that can be associated with the normal construction
period and can be regarded as a normal element of the capitalized cost of the
physical assets of the shopping center because the construction period would have
ended at the end of the year if the typhoon had not occurred. The decision to use
debt capital to finance the shopping center was made with full knowledge that
interest would accrue during the construction period and add to the total cost of
building the center and bringing it to the point at which it would produce revenue.
The future income to be generated by the shopping center must have been
estimated to be more than sufficient to recover all of the expected costs of
14-13
building the center and preparing it for occupancy, including interest during the
construction period.
Instead of treating interest during construction as an element of the cost of the
physical assets, it can be argued that it represents an element of the general cost of
bringing the business to the point of revenue production and should therefore be
treated as an organization cost. This view regards interest during construction as
just another of the many expenditures that are necessary to acquire and organize
the physical assets of a new business but do not attach to any specific assets.
Treated as an organization cost, interest during construction would be expensed as
a start-up cost.
Another alternative to capitalizing an amount equal to the 2013 interest cost is to
treat it as interest expense. This treatment is inappropriate because it assumes that
the decision to use debt capital to finance construction is a decision deliberately to
incur an expense for the interest that accrues during the expected construction
period.
The extension of the construction period to October 2014 because of the typhoon
was externally imposed and so the interest capitalization period continues until
final construction is complete. That is, the additional interest cost is capitalized
and not expensed as a loss from the typhoon.
Cost of obtaining tenants: Both the 2013 and 2014 costs of obtaining tenants
should be capitalized and amortized over the life of the leases. The fact that all of
the tenants who were signed when the typhoon occurred accepted the October
occupancy date indicates that the total cost of obtaining tenants was not affected
by the delay.
The cost of obtaining tenants has a direct and easily identifiable relationship to the
rental income to be earned over the terms of the leases. Under these
circumstances, the problem of reliably measuring periodic net income is best
solved by matching costs with the revenues to which they are directly related.
Promotional advertising: The 2013 cost of promotional advertising should be
written off as a start-up cost. The 2014 cost of promotional advertising should
also be expensed.
The initial expense treatment of the 2013 advertising cost is appropriate because it
is a start-up cost.
The 2014 advertising cost may also be considered as a start-up cost or simply
expensed as advertising cost incurred.
14-14
14-14.

Lee Manufacturing Corporation
General Ledger Accounts

Cash
Accounts receivable
Allowance for doubtful accounts
Inventories
Machinery
Equipment
Accumulated depreciation
Patents
Leasehold improvements
Prepaid expenses
Organization costs
Goodwill
Licensing agreement no. 1
Licensing agreement no. 2
Accounts payable
Unearned revenue
Capital stock
Retained earnings, Jan. 1, 2015
Sales
Cost of goods sold
Trial Balance
Debit
Credit
P 61,000
92,500
P
500
38,500
75,000
29,000
10,000
85,000
26,000
10,500
29,000
24,000
50,000
49,000
Income Statement
Debit
Credit
P
(8)
P 2,500
(1)
(8)
17,000
8,500
(1) P 17,000
(8)
11,000
(9)
(7)
(4)
(5)
(3)
29,000
24,000
1,250
29,250
Balance Sheet
Debit
Credit
61,000
95,000
(500)
38,500
92,000
37,500
(10,000)
68,000
15,000
10,500
19,500
1,000
147,500
12,500
300,000
50,000
P
(3)
1,000
27,000
768,500
454,000
Selling and general expenses

Start-up expenses
173,000
Interest expense
Extraordinary losses
Accumulated amortization:
patents
leasehold improvements
licensing agreements
Prior period adjustment
licensing agreement no. 1
Prior period adjustment
amortization of leasehold
improvements
Net income for 2015
Totals
3,500
12,000
Lee Manufacturing Corporation

Financial Statement Worksheet
For the Year Ended December 31, 2015
Adjustments
Debit
Credit
P1,239,000
P
(2)
(6)
(10)
(7)
(7)
(9)
3,400
5,500
1,500
8,000
16,000
29,000
147,500
13,500
300,000
(27,000)
768,500
464,400
181,000
45,000
3,500
12,000
P1,239,000
(4)
(5)
1,250
29,250
(10)
1,500
P124,400
(2)
3,400
(3,400)
(10)
3,000
(3,000)
(6)
5,500
(5,500)
(30,500) *
P124,400
62,600
768,500
768,500
470,600
(1,500) *
62,600
470,600
Generally, adjustments in the current period that could have been determined by management in a prior period should enter into the determination of net income in the current
period. However, because the 2015 financial statements were not prepared in conformity with generally accepted accounting principles, these retroactive adjustments are
considered to be errors and treated as prior period adjustments and, therefore, should be applied against beginning retained earnings.

14-14.
14-15
Lee Manufacturing Corporation (continued . . . )

Adjusting entries (shown on worksheet):
(1)
(2)
(3)
(4)
Machinery
Patents
To transfer cost of improving
machinery to the fixed asset account.
17,000
17,000
Cost of Goods Sold

Accumulated Amortization: Patents
To record 2015 patent amortization
(1/20 x P68,000).
3,400
Licensing Agreement No. 2

Unearned Revenue
To classify revenue received in advance
on licensing agreement as unearned
revenue.
1,000
Prior Period Adjustment Licensing Agreement

No. 1
To take up 2014 amortization (40 year
life). (Note 1)
3,400
1,000
1,250
1,250
Note 1: Under the revised PAS 38 made

effective January 1, 2005, intangible assets with
indefinite useful lives need not be amortized but
periodically assessed for possible impairment.
This problem may also be solved by
disregarding the 40-year amortization period for
Licensing Agreement #1.
The flood that
rendered Licensing Agreement #1 worthless in
January 2016 should be fully disclosed in the
December 31, 2015 statements.
(5)
Prior Period Adjustment Licensing Agreement

No. 1
To write off the permanent 60%
reduction in the expected revenueproducing value of licensing agreement
no. 1 caused by the December 2014
explosion (60% x P48,750).
29,250
29,250
14-16

(6)
(7)
(8)
(9)
Cost of Goods Sold

Accumulated Amortization: Licensing
Agreements
To record 2015 amortization of
licensing agreement no. 1 [(P50,000
P1,250 P29,250) 39] and no. 2
(P50,000 10).
5,500
5,500
Selling and General Expenses

Start-up Expenses
Goodwill
To transfer items improperly charged to
Goodwill.
8,000
16,000
Start-up Expenses
Organization Costs
To expense other organization costs.
29,000
Equipment
Accounts Receivable Lessor
Leasehold Improvements
To charge the Equipment account with
movable equipment and to record a
receivable from the landlord for the real
estate taxes erroneously paid by Lee.
(10) Cost of Goods Sold

Prior Period Adjustment Amortization of
Leasehold Improvements
Accumulated Amortization: Leasehold
Improvements
To record 2014 and 2015 amortization
of leasehold improvements based on
10-year life of lease (2 x 10% x
P15,000).
24,000
29,000
8,500
2,500
11,000
1,500
1,500
3,000

14-15.
14-17
Broadway Corporation
Requirement (1)
Intangibles Section of Balance Sheet
December 31, 2015
Franchise from IE Copy Service, Inc., net of
accumulated amortization of P6,870 (Schedule 1)
Patent, net of accumulated amortization of P2,050
(Schedule 2)
Trademark, net of accumulated amortization of
P7,294 (Schedule 3)
Total intangibles
P 61,830
14,350
42,706
P118,886
Schedule 1:
Computation of Franchise from
IE Copy Service, Inc.
Cost of franchise at January 1, 2015
Down payment
Present value of installments
Initial amount capitalized
Amortization of franchise for 2015 (P68,700 10
years)
Franchise balance, December 31, 2015
P25,000
43,700
P68,700
(6,870)
P61,830
Schedule 2:
Computation of Patent
Capitalized cost of patent at January 2, 2015 legal
fees and other costs associated with registration
Amortization of patent for 2015 (P16,400 8 years)
Patent balance, December 31, 2015
P16,400
(2,050)
P14,350
14-18

Schedule 3:
Computation of Trademark
Cost of trademark at July 1, 2012

Amortization through December 31, 2015
(P40,000 20 years = P2,000 x 3 years)
Balance, December 31, 2015
Deduct accumulated amortization
Trademark balance, December 31, 2015
Cost
P40,000
P40,000
(7,000)
P33,000
Accumulated
Amortization
P7,000
P7,000
Cost of successful litigation in defense of trademark should be charged to

expense.
Requirement (2)
Expenses Resulting from Intangibles Transactions
For the Year Ended December 31, 2015
Franchise from IE Copy Service, Inc.
Amortization of franchise (Schedule 1)
Franchise fee on revenues from operations
(P900,000 x 5%)
Imputed interest expense on unpaid balance of
initial franchise fee (P43,700 x 14%)
Amortization of patent (Schedule 2)
Litigation expense Trademark
Amortization of trademark
Total expenses
14-16.
P 6,870
45,000
6,118
P57,988
2,050
10,000
2,000
P72,038
Precious Opal Corporation

(a) 2015 amortization: P16,000 10 = P1,600.
12/31/06 book value: P16,000 P1,600 = P14,400.
2016 amortization: (P16,000 10) = P1,600.
12/31/07 book value: (P16,000 P3,200) = P12,800.
(b) 2016 amortization: (P12,800) 4 = P3,200.
12/31/16 book value: P12,800 P3,200 = P9,600.
Legal fees in successfully defending the trade name should be charged to
expense.
14-19
(c) Carrying amount (P19,733) > Fair Value (P15,000); thus the tradename fails
the recoverability test. The new carrying value is P15,000.
The fair value is considered the recoverable amount. The estimated total
future flows from the trade name of P16,000 need to be discounted and the
resulting present value would in most probability be a lower amount than
P15,000.
2017 amortization (after recording impairment loss):
P15,000 8 = P1,875.
12/31/17 book value: P15,000 P1,875 = P13,125
14-17.
Miguel Alfonso Corporation

Requirement (a)
Attorneys fees in connection with organization
of the corporation
Costs of meetings of incorporators to discuss
organizational activities
State filing fees to incorporate
Total organization costs
P15,000
7,000
1,000
P23,000
Drafting and design equipment, P10,000, should be classified as part of fixed

assets, rather than as organization costs.
Requirement (b)
Organization Expense ................................................................ 23,000
Cash (Payables)................................................................
23,000
14-18.
Jo Tan Company
Requirement (a)
Jo Tan Company
INTANGIBLES SECTION OF BALANCE SHEET
December 31, 2016
Patent from Francis Argante Company, net of accumulated

amortization of P560,000 (Schedule 1)
Franchise from JC Company, net of accumulated
amortization of P48,000 (Schedule 2)
Total intangibles
P1,440,000
432,000
P1,872,000
14-20
Schedule 1 Computation of Patent from Francis Argante Company

Cost of patent at date of purchase
Amortization of patent for 2015 (P2,000,000 10 years)
Amortization of patent for 2016 (P1,800,000 5 years)
Patent balance
P2,000,000
(200,000)
1,800,000
(360,000)
P1,440,000
Schedule 2 Computation of Franchise from JC Company

Cost of franchise at date of purchase
Amortization of franchise for 2013 (P480,000 10)
Franchise balance
P 480,000
(48,000)
P 432,000
Requirement (b)
Jo Tan Company
Income Statement Effect
For the year ended December 31, 2016
Patent from Francis Argante Company:
Amortization of patent for 2016
(P1,800,000 5 years)
Franchise from JC Company:
Amortization of franchise for 2016
(P480,000 10)
Payment to Reagan Company
(P2,500,000 X 5%)
Research and development costs
Total charged against income
14-19.
P360,000
P 48,000
125,000
173,000
433,000
P966,000
Twinkle Industries
Requirement (a)
Patent X
Life in years
Life in months (12 X 17)
Amortization per month
Number of months amortized to date
Year
2013
2014
2015
2016
Month
10
12
12
12
46
Book value 12/31/16 P23,700: (P30,600 [46 X P150])
17
204
P150

Patent Y
Life in years
Year
2014
2015
2016
14-21
10
120
P125
Month
6
12
12
30
Book value 12/31/16 P11,250: (P15,000 [P125 X 30])

Patent Z
Life in years
Year
2015
2016
4
48
P300
Month
4
12
16
Book value 12/31/16 P9,600: (P14,400 [P300 X 16])

At December 31, 2016
Patent X
Patent Y
Patent Z
Total
P23,700
11,250
9,600
P44,550
Requirement (b)
Analysis of 2017 transactions
1.
The P245,700 incurred for research and development should be expensed.
2.
The book value of Patent Y is P11,250 and its estimated future cash flows are
P6,000: (3 X P2,000) therefore Patent Y is impaired. The impairment
loss is imputed as follows:
Book value
Less: Present value of future
cash flows 2,000 X 2.57710
Loss recognized
P11,250
5,154
P 6,096
14-22

Patent Y carrying amount (12/31/17) P5,154
At December 31, 2017
Patent X
Patent Y
Patent Z
Patent AA
Total
P21,900
5,164
6,000
34,560
P67,624
(P23,700 [12 X P150])

(Present value of future cash flows)
(P9,600 [12 X P300])
(P36,480 P1,920*)
Patent AA amortization
Life in years
Life in months
P320 X 6 = P1,920
9 1/2
114
P320
Patent Y: Value in Use

2,000
2,000
2,000
x
x
x
0.9259 =
0.8573 =
0.7983 =
P1,852
1,715
1,597
P5,164
or
2,000
14-20.
2.582 =
P5,164
Depp Corporation
Requirement (a)
Cash ................................................................................................
50,000
Receivables ................................................................................................
90,000
Inventory ................................................................................................
125,000
Land ................................................................................................
60,000
Buildings ................................................................................................
75,000
Equipment ................................................................................................
70,000
Trademarks ................................................................................................
15,000
Goodwill ................................................................................................
65,000
Accounts Payable ................................................................
200,000
Notes Payable ................................................................
100,000
Cash ................................................................................................ 250,000
Note that the building and equipment would be recorded at the 7/1/15 cost to
Brigham; accumulated depreciation accounts would not be recorded.
14-23

Requirement (b)
1. Amortization Expense (Trademarks) ................................ 1,500
Trademarks ([P15,000 P3,000] 1/4 X 6/12)................................
1,500
2. Goodwill will not be amortized.

14-21.
Bill Santos Company

Requirement (a)
December 31, 2015
Loss on Impairment ................................................................
1,100,000*
Copyrights ................................................................
*Carrying amount
Fair value
Loss on impairment
1,100,000
P4,300,000
3,200,000
P1,100,000
Requirement (b)
Copyright Amortization Expense ................................
320,000*
Copyrights ................................................................
*New carrying amount
Useful life
Amortization per year
CV 12.31.15
Amortization, 2016
CV 12.31.16
Historical Cost
P4,300,000
430,000
P3,870,000
320,000
P3,200,000
10 years
P 320,000
Fair Value
12.31.07
Fair Value
P3,200,000
320,000
P2,880,000
Recovery
P3,400,000
520,000
Requirement (c)
Copyrights ................................................................................................
520,000
Copyright Amortization Expense
or Gain on Recovery of Previously
Recognized Impairment ................................
520,000
14-24
14-22.

Espaol Co.
Franchises................................................................................................
42,000
Prepaid Rent ................................................................................................
28,000
Retained Earnings (Organization Costs of P6,000 in
2015) ................................................................................................
6,000
Retained Earnings (P16,000 P6,000) ................................ 10,000
Patents ................................................................................................
74,000
Legal fees ................................................................................................
12,650
Research and Development Expense ................................................................
(P75,000 + P160,000) ................................................................
235,000
Goodwill................................................................................................
278,400
Intangible Assets ................................................................
686,050
5,250
Franchise Amortization Expense (P42,000 8)................................
Retained Earnings (P42,000 8 X 6/12)................................ 2,625
Franchises ................................................................
7,875
14,000
Rent Expense (P28,000 2)................................................................
Retained Earnings (P28,000 2 X 3/12)................................ 3,500
Prepaid Rent ................................................................
17,500
Patent Amortization Expense ................................................................

7,400
Patents ................................................................................................
7,400
(P74,000 10)
NoteNo amortization of goodwill; goodwill should be tested for impairment on
at least an annual basis in future periods.
14-23.
Sim Laboratories
Requirement (a)
Costs to obtain patent Jan. 2008
1996 amortization (P62,050 17)
Carrying value, 12/31/08
P62,050
(3,650)
P58,400
All costs incurred prior to January 2008 are related to research and development
activities and were expensed as incurred.
14-25
Requirement (b)
1/1/09 carrying value of patent
2010 amortization
Legal fees to defend patent 12/10
2012 amortization
P58,400
P3,650
3,650
6,200
6,200
(7,300)
51,100
35,700
86,800
(12,400)
P74,400
The costs incurred in 2009 and 2011 are related to research and development
activities and are expensed as incurred. Legal fees in successful defense of the
patent in 2001 could be capitalized and considered GAAP.
Requirement (c)
1/1/13 carrying value
2014 amortization
2015 amortization
P74,400
P14,880
14,880
14,880
(44,640)
P29,760
The legal costs in 2015 were expensed because the suit was unsuccessful. Even if
the lawsuit was successful, the legal fees would be likewise charged to expense.
This is in accordance with PAS 38, Intangibles which was made effective in 2004.

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CHAPTER

The decision whether a given expenditure on intangible asset to be treated as

Research and Development Costs vary widely among companies. Many

Applied Auditing 2014 Edition Solutions Manual

Process Development Company

Amortization Per Client

* Based on 17 years legal life.

(b) 2007 to 2014 Amortization:

Substantive Tests of Intangible Assets

Adjusting Journal Entries

Capital in excess of par value

Accumulated amortization Patent P

Research and Development Expenses

* Alternatively, unused materials and

Applied Auditing 2014 Edition Solutions Manual

Income Summary / Retained Earnings

Research and Development Expenses

Research and Development Expenses

Research and Development Expenses

PAS 38 prohibits capitalization of start-up expenses such as organization costs.

Substantive Tests of Intangible Assets

Net tangible assets per records, Nov. 1, 2015

Excess annual pre-tax earnings

Goodwill (excess earnings capitalized at 25%)

Schedule 2: Goodwill of Lead, Inc.

Average pre-tax earnings 11.1.10 to 11.1.15

Excess annual pre-tax earnings

Goodwill (excess earnings capitalized at 25%)

Phoenix Supply Company

Applied Auditing 2014 Edition Solutions Manual

Oct. 31 Amortization of Patents

Mar. 7 Loss on Patent A

Substantive Tests of Intangible Assets

Amortization for 2014 and 2015:

Applied Auditing 2014 Edition Solutions Manual

37,125 [AJE (6)]

No amortization need be taken up in 2015. With the effectivity of PAS 38

Substantive Tests of Intangible Assets

Effective January 2005, Revised PAS 36 prohibits amortization of intangibles

Adjusting Journal Entries:

AJE (2) Cost of Goods Sold

AJE (4) Selling and Administrative

AJE (6) Retained Earnings

AJE (7) Retained Earnings

Applied Auditing 2014 Edition Solutions Manual

AJE (9) Retained Earnings

(2) Cost of Goods Sold

Substantive Tests of Intangible Assets

Treat all the items as expenses in

No depreciation was taken on

Expense appropriate amounts in the

Ordinary shares account does not

Increase ordinary shares by par

The statement should be provided,

No accumulated deficit presented.

Deficit accumulated during

Applied Auditing 2014 Edition Solutions Manual

Income statement, including amounts of revenue and expenses recognized

Statement of cash flows, including cumulative amounts of sources and uses of

Additional disclosures: identification of the company as a development-stage

Golden Springs Shopping Center, Inc.

Substantive Tests of Intangible Assets

Applied Auditing 2014 Edition Solutions Manual

General Ledger Accounts