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Chapter 12: Question 3 (page 637)

Intangibles have either a limited useful life or an indefinite useful life. How should these two different types of intangibles be amortized?

Short Answer

Expert verified

Intangibles have either a limited useful life or an indefinite useful life. Intangibles with limited life can be amortized, but intangibles with an endless life cannot be amortized.

Step by step solution

01

Meaning of Amortization

Amortization is a strategy used in accounting to reduce the book value of a loan or intangible asset over a predetermined period.

02

Amortization of Intangibles

The limited-life intangibles should be amortized over their useful life by systematic charges to expenditure.

It is not possible to amortize an intangible asset with endless life.

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Most popular questions from this chapter

Recently, a group of university students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct?

(Accounting for Pre-Opening Costs) After securing lease commitments from several major stores, Auer Shopping Center, Inc. was organized and built a shopping center in a growing suburb.

The shopping center would have opened on schedule on January 1, 2017, if it had not been struck by a severe tornado in December. Instead, it opened for business on October 1, 2017. All of the additional construction costs that were incurred as a result of the tornado were covered by insurance.

In July 2016, in anticipation of the scheduled January opening, a permanent staff had been hired to promote the shopping center, obtain tenants for the uncommitted space, and manage the property.

A summary of some of the costs incurred in 2016 and the first nine months of 2017 follows.

2016

January 1, 2017, through September 30, 2017

Interest on mortgage bonds

\(720,000

\)540,000

Cost of obtaining tenants

300,000

360,000

Promotional advertising

540,000

557,000

The promotional advertising campaign was designed to familiarize shoppers with the center. Had it been known in time that the center would not open until October 2017, the 2016 expenditure for promotional advertising would not have been made. The advertising had to be repeated in 2017.

All of the tenants who had leased space in the shopping center at the time of the tornado accepted the October occupancy date on the condition that the monthly rental charges for the first 9 months of 2017 be canceled.

Instructions

Explain how each of the costs for 2016 and the first 9 months of 2017 should be treated in the accounts of the shopping center corporation. Give the reasons for each treatment.

Merck and Johnson & Johnson

Question: Merck & Co., Inc. and Johnson & Johnson are two leading producers of healthcare products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of a new healthcare product is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and \(200 million to develop its 1-DAY ACUVUE contact lenses. Below are some basic data compiled from the financial statements of these two companies.

(all dollars in millions)

Johnson & Johnson

Merck

Total assets

\)53,317

\(42,573

Total revenue

47,348

22,939

Net income

8,509

5,813

Research and development expense

5,203

4,010

Intangible assets

11,842

2,765

Instructions

  1. What kinds of intangible assets might a healthcare products company have? Does the composition of these intangibles matter to investors—that is, would it be perceived differently if all of Merck’s intangibles were goodwill than if all of its intangibles were patents?
  2. Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditures the company could have reported \)4 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditures for at least a couple of years. What would you advise?
  3. The notes to Merck’s financial statements note that Merck has goodwill of $1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on a company’s books?

Question: (Goodwill, Impairment) On July 31, 2017, Mexico Company paid \(3,000,000 to acquire all of the common stock of Conchita Incorporated, which became a division of Mexico. Conchita reported the following balance sheet at the time of the acquisition.

Current assets

\) 800,000

Current liabilities

\( 600,000

Noncurrent assets

2,700,000

Long-term liabilities

500,000

Total assets

\)3,500,000

Stockholders’ equity

2,400,000

Total liabilities and stockholders’ equity

\(3,500,000

It was determined at the date of the purchase that the fair value of the identifiable net assets of Conchita was \)2,750,000. Over the next 6 months of operations, the newly purchased division experienced operating losses. In addition, it now appears that it will generate substantial losses for the foreseeable future. At December 31, 2017, Conchita reports the following balance sheet information.

Current assets

\( 450,000

Noncurrent assets (including goodwill recognized in purchase)

2,400,000

Current liabilities

(700,000)

Long-term liabilities

(500,000)

Net assets

\)1,650,000

It is determined that the fair value of the Conchita Division is \(1,850,000. The recorded amount for Conchita’s net assets (excluding goodwill) is the same as fair value, except for property, plant, and equipment, which has a fair value \)150,000 above the carrying value.

Instructions

  1. Compute the amount of goodwill recognized, if any, on July 31, 2017.
  2. Determine the impairment loss, if any, to be recorded on December 31, 2017.
  3. Assume that fair value of the Conchita Division is \(1,600,000 instead of \)1,850,000. Determine the impairment loss, if any, to be recorded on December 31, 2017.

Prepare the journal entry to record the impairment loss, if any, and indicate where the loss would be reported in the income statement.

In what situation will the unrealized holding gain or loss on inventory be reported in income?
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