Question: (Accounting for Patents, Franchises, and R&D) Carter Company has provided information on intangible assets as follows.

A patent was purchased from Ford Company for \(2,000,000 on January 1, 2016. Carter estimated the remaining useful life of the patent to be 10 years. The patent was carried in Ford’s accounting records at a net book value of \)2,000,000 when Ford sold it to Carter.

During 2017, a franchise was purchased from Polo Company for \(480,000. In addition, 5% of revenue from the franchise must be paid to Polo. Revenue from the franchise for 2017 was \)2,500,000. Carter estimates the useful life of the franchise to be 10 years and takes a full year’s amortization in the year of purchase.

Carter incurred research and development costs in 2017 as follows.

Materials and equipment	\(142,000
Personnel	189,000
Indirect costs	102,000
	\)433,000

Carter estimates that these costs will be recouped by December 31, 2020. The materials and equipment purchased have no alternative uses.

On January 1, 2017, because of recent events in the field, Carter estimates that the remaining life of the patent purchased on January 1, 2016, is only 5 years from January 1, 2017.

Instructions

1. Prepare a schedule showing the intangibles section of Carter’s balance sheet at December 31, 2017. Show supporting computations in good form.
2. Prepare a schedule showing the income statement effect (related to expenses) for the year ended December 31, 2017, as a result of the facts above. Show supporting computations in good form.

Step by step solution

01

 Step 1: Meaning of Intangible assets

Intangible assets are assets that do not have a physical form. Organizations that have spent a significant amount of money to establish brands may find that the value of their intangible assets much outweighs the worth of their physical assets. A large number of physical resources, such as buildings, land, and machinery, are frequently present in an organization.

02

Preparing a schedule showing the intangibles section of Carter’s balance sheet on December 31, 2017 (a)

CARTER COMPANY Intangibles Section of Balance Sheet December 31, 2017
Patent from Ford Company, net of accumulated amortization of $560,000 (Schedule 1)	$1,440,000
The franchise from Polo Company, net of accumulated amortization of $48,000 (Schedule 2)	432,000
Total intangibles	$1,872,000
Schedule 1 Computation of Patent from Ford Company Cost of the patent at the date of purchase	$2,000,000
Amortization of patent for 2016	(200,000)
	1,800,000
Amortization of patent for 2017	(360,000)
Patent balance	$1,440,000
Schedule 2 Computation of Franchise from Polo Company Cost of the franchise at the date of purchase	$ 480,000
Amortization of franchise for 2017	(48,000)
Franchise balance	$ 432,000

Working notes:

Calculation of the amount of amortization of patent for 2016

$$\begin{gathered} \text{Amortization}\text{of}\text{patent}=\frac{\text{Patent}\text{cost}}{\text{Useful}\text{life}} \\ =\frac{\$2,000,000}{10} \\ =\$200,000 \end{gathered}$$

Calculation of the amount of amortization of patent for 2017

$$\begin{gathered} \text{Amortization}\text{of}\text{patent}=\frac{\text{Patent}\text{cost}}{\text{Useful}\text{life}} \\ =\frac{\$1,800,000}{5} \\ =\$360,000 \end{gathered}$$

Calculation of the amount of amortization of franchise for 2017

$$\begin{gathered} \text{Amortization}\text{of}\text{franchise}=\frac{\text{Franchise}\text{cost}}{\text{Useful}\text{life}} \\ =\frac{\$480,000}{10} \\ =\$48,000 \end{gathered}$$

03

Preparing a schedule showing the income statement effect for the year ended December 31, 2017 (b)

CARTER COMPANY Income Statement Effect For the year ended December 31, 2017
Patent from Ford Company:
Amortization of patent for 2017	$360,000
The franchise from Polo Company:
Amortization of franchise for 2017 $ 48,000
Payment to Polo Company 125,000	173,000
Research and development costs	433,000
Total charged against income	$966,000

Working notes:

Calculation of amortization of franchise for 2017

$$\begin{gathered} \text{Amortization}\text{of}\text{franchise}=\frac{\text{Franchise}\text{cost}}{\text{Useful}\text{life}} \\ =\frac{\$480,000}{10} \\ =\$48,000 \end{gathered}$$

Calculation of payment to Polo Company

$$\begin{gathered} \text{Payment}\text{to}\text{polo}\text{company}=\text{Revenue}\text{from}\text{franchise}\times \text{rate}\text{of}\text{revenue} \\ =\$2,500,000\times 5\% \\ =\$125,000 \end{gathered}$$

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