Chapter Eight

Intangible Assets

8.1. Characteristics
The world economy is dominated by information and service providers. For these companies, their major
assets are often intangible in nature.
What exactly are intangible assets? Intangible assets have three main characteristics:
1. They are identifiable. To be identifiable, an intangible asset must either be separable from the
company (can be sold or transferred), or it arises from a contractual or legal right from which
economic benefits will flow to the company.
2. They lack physical existence. Tangible assets such as property, plant, and equipment have physical
form. Intangible assets, in contrast, derive their value from the rights and privileges granted to the
company using them.
3. They are not monetary assets. Assets such as bank deposits, accounts receivable, and long-term
investments in bonds and shares also lack physical substance. How-ever, monetary assets derive their
value from the right (claim) to receive cash or cash equivalents in the future. Monetary assets are not
classified as intangibles.
In most cases, intangible assets provide benefits over a period of years. Therefore, companies normally
classify them as non-current assets.
8.2. Valuation
Purchased Intangibles
Companies record at cost intangibles purchased from another party. Cost includes all acquisition costs
plus expenditures to make the intangible asset ready for its intended use. Typical costs include purchase
price, legal fees, and other incidental expenses.
Sometimes companies acquire intangibles in exchange for shares or other assets. In such cases, the cost
of the intangible is the fair value of the consideration given or the fair value of the intangible received,
whichever is more clearly evident. What if a company buys several intangibles, or a combination of
intangibles and tangibles? In such a “basket purchase,” the company should allocate the cost on the basis
of fair values. Essentially, the accounting treatment for purchased intangibles closely parallels that for
purchased tangible assets.

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Internally Created Intangibles
Businesses frequently incur costs on a variety of intangible resources, such as scientific or technological
knowledge, market research, intellectual property, and brand names. These costs are commonly referred
to as research and development (R&D) costs. Intangible assets that might arise from these expenditures
include patents, computer soft-ware, copyrights, and trademarks. For example, Nokia incurred R&D
costs to develop its communications equipment, resulting in patents related to its technology. In
determining the accounting for these costs, Nokia must determine whether its R&D project is at a
sufficiently advanced stage to be considered economically viable. To perform this assessment, Nokia
evaluates costs incurred during the research phase and the development phase.
Illustration below indicates the two stages of research and development activities, along with the
accounting treatment for costs incurred during these phases.

Beginning of Ready for

Project Sale or Use

$$$ Expenditures $$$

Research Phase Development Phase

Expense Capitalize

Economic Viability

As indicated, all costs incurred in the research phase are expensed as incurred. Once a project moves to the
development phase, certain development costs are capitalized. Specifically, development costs are capitalized
when certain criteria are met, indicating that an economically viable intangible asset will result from the R&D
project. In essence, economic viability indicates that the project is far enough along in the process such that the
economic benefits of the R&D project will flow to the company. Therefore, development costs incurred from that
point forward meet the recognition criteria and should be recorded as an intangible asset.

In summary, companies expense all research phase costs and some development phase costs. Certain
development costs are capitalized once economic viability criteria are met. IFRS identifies several specific
criteria that must be met before development costs are capitalized (which we discuss in more detail later in
the chapter).
8.3. Amortization of Intangibles
The allocation of the cost of intangible assets in a systematic way is called amortization. Intangibles have
either a limited (finite) useful life or an indefinite useful life.

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Limited Life Intangibles
Companies amortize their limited-life intangibles by systematic charges to expense over their useful life.
The useful life should reflect the periods over which these assets will contribute to cash flows.
Disney, for example, considers these factors in determining useful life:
 The expected use of the asset by the company.
 The effects of obsolescence, demand, competition, and other economic factors. Examples include the
stability of the industry, known technological advances, legislative action that results in an uncertain
or changing regulatory environment, and expected changes in distribution channels.
 Any provisions (legal, regulatory, or contractual) that enable renewal or extension of the asset’s legal
or contractual life without substantial cost. This factor assumes that there is evidence to support
renewal or extension. Disney also must be able to accomplish renewal or extension without material
modifications of the existing terms and conditions.
 The level of maintenance expenditure required to obtain the expected future cash flows from the
asset. For example, a material level of required maintenance in relation to the carrying amount of the
asset may suggest a very limited useful life.
 Any legal, regulatory, or contractual provisions that may limit the useful life.
 The expected useful life of another asset or a group of assets to which the useful life of the intangible
asset may relate (such as lease rights to a studio lot).
The amount of amortization expense for a limited-life intangible asset should reflect the pattern in which
the company consumes or uses up the asset, if the company can reliably determine that pattern. For
example, assume that Second Wave, Inc. purchases a license to provide a specified quantity of a gene
product called Mega. Second Wave should amortize the cost of the license following the pattern of use of
Mega. If Second Wave’s license calls for it to provide 30 percent of the total the first year, 20 percent the
second year, and 10 percent per year until the license expires, it would amortize the license cost using
that pattern. If it cannot determine the pattern of production or consumption, Second Wave should use the
straight-line method of amortization. (For home-work problems, assume the use of the straight-line
method unless stated otherwise.) When Second Wave amortizes this license, it should show the charges
as expenses. It should credit either the appropriate asset accounts or separate accumulated amortization
accounts.
The amount of an intangible asset to be amortized should be its cost less residual value. The residual
value is assumed to be zero, unless at the end of its useful life the in-tangible asset has value to another
company.

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IFRS requires companies to assess the estimated residual values and useful lives of intangible assets at
least annually. What happens if the life of a limited-life intangible asset changes? In that case, the
remaining carrying amount should be amortized over the revised remaining useful life. Companies must
also evaluate the limited-life intangibles annually to determine if there is an indication of impairment. If
there is indication of impairment, an impairment test is performed. An impairment loss should be
recognized for the amount that the carrying amount of the intangible is greater than the recoverable
amount. Recall that the recover-able amount is the greater of the fair value less costs to sell or value-in-
use.
Indefinite Life Intangibles
If no factors (legal, regulatory, contractual, competitive, or other) limit the useful life of an intangible
asset, a company considers its useful life indefinite. An indefinite life means that there is no foreseeable
limit on the period of time over which the intangible asset is expected to provide cash flows. A company
does not amortize an intangible as-set with an indefinite life. To illustrate, assume that Double Clik Inc.
acquired a trade-mark that it uses to distinguish a leading consumer product. It renews the trademark
every 10 years. All evidence indicates that this trademark product will generate cash flows for an
indefinite period of time. In this case, the trademark has an indefinite life; Double Clik does not record
any amortization.
Companies also must test indefinite-life intangibles for impairment at least annually. The impairment test
for indefinite-life intangibles is similar to the one for limited-life intangibles. That is, an impairment loss
should be recognized for the amount that the carrying amount of the indefinite-life intangible asset is
greater than the recoverable amount.
Illustration below summarizes the accounting treatment for intangible assets.

8.4. Types of Intangible Assets

There are many different types of intangibles, often classified into the following six major categories.
1. Marketing-related intangible assets.
2. Customer-related intangible assets.

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3. Artistic-related intangible assets.
4. Contract-related intangible assets.
5. Technology-related intangible assets.
6. Goodwill.
1. Marketing-Related Intangible Assets
Companies primarily use marketing-related intangible assets in the marketing or pro-motion of products
or services. Examples are trademarks or trade names, newspaper mastheads, Internet domain names, and
non-competition agreements.
A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular
company or product. Trade names like Mercedes-Benz, Pepsi-Cola, Honda, Cadbury Eggs, Wheaties, and
Ikea create immediate product identification in our minds, thereby enhancing marketability.
Under common law, the right to use a trademark or trade name, whether registered or not, rests
exclusively with the original user as long as the original user continues to use it. For example, in the
United States, registration with the U.S. Patent and Trademark Office provides legal protection for an
indefinite number of renewals for periods of 10 years each. Therefore, a company that uses an established
trademark or trade name may properly consider it to have an indefinite life and does not amortize its cost.
If a company buys a trademark or trade name, it capitalizes the cost at the purchase price. If a company
develops a trademark or trade name, it capitalizes costs related to securing it, such as attorney fees,
registration fees, design costs, consulting fees, and successful legal defense costs. However, it excludes
research costs and development costs that do not meet recognition criteria. When the total cost of a
trademark or trade name is insignificant, a company simply expenses it.
2. Customer-Related Intangible Assets
Customer-related intangible assets result from interactions with outside parties. Examples include
customer lists, order or production backlogs, and both contractual and non-contractual customer
relationships.
To illustrate, assume that Green Market Inc. acquires the customer list of a large newspaper for 6,000,000
on January 1, 2015. This customer database includes name, contact details, order history, and
demographic information. Green Market expects to benefit from the information evenly over a three-year
period. In this case, the customer list is a limited-life intangible that Green Market should amortize on a
straight-line basis.
Green Market records the purchase of the customer list and the amortization of the customer list at the
end of each year as follows.

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 January 1, 2015
Customer List 6,000,000
Cash 6,000,000
(To record purchase of customer list)
December 31, 2015, 2016, 2017
Amortization Expense (customer list) 2,000,000
Customer List (or Accumulated Customer List Amortization) 2,000,000
(To record amortization expense)
The preceding example assumed no residual value for the customer list. But what if Green Market
determines that it can sell the list for 60,000 to another company at the end of three years? In that case,
Green Market should subtract this residual value from the cost in order to determine the amortization
expense for each year. Amortization expense would be 1,980,000 per year, as shown in Illustration
below:

Cost 6,000,000
Residual value (60,000)
Amortization base 5,940,000
Amortization expense per period: 1,980,000 (5,940,000 / 3)

Companies should assume a zero residual value unless the asset’s useful life is less than the economic life
and reliable evidence is available concerning the residual value.
3. Artistic-Related Intangible Assets
Artistic-related intangible assets involve ownership rights to plays, literary works, musical works,
pictures, photographs, and video and audiovisual material. Copyrights protect these ownership rights.
A copyright is a government-granted right that all authors, painters, musicians, sculptors, and other artists
have in their creations and expressions. A copyright is granted for the life of the creator plus 70 years. It
gives the owner or heirs the exclusive right to reproduce and sell an artistic or published work.
Copyrights are not renewable.

4. Contract-Related Intangible Assets

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Contract-related intangible assets represent the value of rights that arise from contractual arrangements.
Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or
supply contracts.
A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell
certain products or services, to use certain trademarks or trade names, or to perform certain functions,
usually within a designated geographical area.
The franchisor, having developed a unique concept or product, protects its concept or product through a
patent, copyright, or trademark or trade name. The franchisee acquires the right to exploit the franchisor’s
idea or product by signing a franchise agreement.
Another type of franchise arrangement, granted by a governmental body, permits a business to use public
property in performing its services. Examples are the use of city streets for a bus line or taxi service; the
use of public land for telephone, electric, or cable television lines; and the use of airwaves for radio or
TV broadcasting. Such operating rights are referred to as licenses or permits.

Franchises and licenses may be for a definite period of time, for an indefinite period of time, or perpetual.
The company securing the franchise or license carries an intangible asset account (entitled Franchises or
Licenses) on its books, only when it can identify costs with the acquisition of the operating right. (Such
costs might be legal fees or an advance lump-sum payment, for example.) A company should amortize
the cost of a franchise (or license) with a limited life as operating expense over the life of the franchise.

It should not amortize a franchise with an indefinite life nor a perpetual franchise; the company should
instead carry such franchises at cost.
Annual payments made under a franchise agreement should be entered as operating expenses in the
period in which they are incurred. These payments do not represent an asset since they do not relate to
future rights to use the property.
5. Technology-Related Intangible Assets
Technology-related intangible assets relate to innovations or technological advances. Examples are
patented technology and trade secrets granted by a governmental body.
In many countries, a patent gives the holder exclusive right to use, manufacture, and sell a product or
process for a period of 20 years without interference or infringement by others. The two principal kinds
of patents are product patents, which cover actual physical products, and process patents, which govern
the process of making products.

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Companies should amortize the cost of a patent over its legal life or its useful life (the period in which
benefits are received), whichever is shorter. If Samsung owns a patent from the date it is granted and
expects the patent to be useful during its entire legal life, the company should amortize it over 20 years. If
it appears that the patent will be useful for a shorter period of time, say, for five years, it should amortize its
cost over five years.

Changing demand, new inventions superseding old ones, inadequacy, and other factors often limit the
useful life of a patent to less than the legal life. For example, the useful life of pharmaceutical patents is
frequently less than the legal life because of the testing and approval period that follows their issuance. A
typical drug patent has several years knocked off its 20-year legal life. Why? Because, in the United States,
a drug-maker spends one to four years on animal tests, four to six years on human tests, and two to three
years for the U.S. Food and Drug Administration to review the tests. All this time occurs after issuing the
patent but before the product goes on pharmacists’ shelves.

As mentioned earlier, companies capitalize the costs of defending copyrights. The accounting treatment for
a patent defense is similar. A company charges all legal fees and other costs incurred in successfully
defending a patent suit to Patents, an asset account. Such costs should be amortized along with acquisition
cost over the remaining useful life of the patent.

Amortization expense should reflect the pattern, if reliably determined, in which a company uses up the
patent. A company may credit amortization of patents directly to the Patents account or to an Accumulated
Patent Amortization account. To illustrate, assume that Harcott Co. incurs $180,000 in legal costs on
January 1, 2015, to successfully defend a patent. The patent’s useful life is 20 years, amortized on a
straight-line basis. Harcott records the legal fees and the amortization at the end of 2015 as follows:
January 1, 2015
Patents 180,000
Cash 180,000
(To record legal fees related to patent)
December 31, 2015
Patent Amortization Expense ($180,000 / 20) 9,000
Patents (or Accumulated Patent Amortization) 9,000
(To record amortization of patent)
6. Goodwill
Although companies may capitalize certain costs incurred in developing specifically identifiable assets
such as patents and copyrights, the amounts capitalized are generally insignificant. But companies do

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record material amounts of intangible assets when purchasing intangible assets, particularly in situations
involving a business combination (the purchase of another business).

To illustrate, assume that Portofino Company decides to purchase Aquinas Company. In this situation,
Portofino measures the assets acquired and the liabilities assumed at fair value. In measuring these assets
and liabilities, Portofino must identify all the assets and liabilities of Aquinas. As a result, Portofino may
recognize some assets or liabilities not previously recognized by Aquinas. For example, Portofino may
recognize intangible assets such as a brand name, patent, or customer list that were not recorded by
Aquinas. In this case, Aquinas may not have recognized these assets because they were developed
internally and charged to expense.

In many business combinations, the purchasing company records goodwill. Goodwill is measured as the
excess of the cost of the purchase over the fair value of the identifiable net assets (assets less liabilities)
purchased. For example, if Portofino paid $2,000,000 to purchase Aquinas’s identifiable net assets (with
a fair value of $1,500,000), Portofino records goodwill of $500,000. Goodwill is therefore measured as a
residual rather than measured directly. That is why goodwill is sometimes referred to as a plug, a gap
filler, or a master valuation account.

Conceptually, goodwill represents the future economic benefits arising from the other assets acquired in a
business combination that are not individually identified and separately recognized. It is often called “the
most intangible of the intangible assets” because it is identified only with the business as a whole. The
only way to sell goodwill is to sell the business.
Recording Goodwill
Internally Created Goodwill: Goodwill generated internally should not be capitalized in the accounts.
The reason? Measuring the components of goodwill is simply too complex and associating any costs with
future benefits are too difficult. The future benefits of goodwill may have no relationship to the costs
incurred in the development of that goodwill. To add to the mystery, goodwill may even exist in the
absence of specific costs to develop it. Finally, because no objective transaction with outside parties takes
place, a great deal of subjectivity—even misrepresentation— may occur.
Purchased Goodwill: As indicated earlier, goodwill is recorded only when an entire business is
purchased. To record goodwill, a company compares the fair value of the net tangible and identifiable
intangible assets with the purchase price (cost) of the acquired business. The difference is considered
goodwill.

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Goodwill is the residual—the excess of cost over fair value of the identifiable net assets acquired. To
illustrate, Feng, Inc. decides that it needs a parts division to supplement its existing tractor
distributorship. The president of Feng is interested in buying Tractorling S.A., a small concern in São
Paulo, Brazil. Illustration 12-4 presents Tractorling’s statement of financial position.

After considerable negotiation, Tractorling decides to accept Feng’s offer of $400,000. What, then, is the
value of the goodwill, if any? The answer is not obvious. Tractorling’s historical cost-based statement of
financial position does not disclose the fair values of its identifiable assets. Suppose, though, that as the
negotiations progress, Feng investigates Tractorling’s underlying assets to determine their fair values.
Such an investigation may be accomplished either through a purchase audit undertaken by Feng or by an
independent appraisal from some other source. The investigation determines the valuations shown in
Illustration below.

Fair Values
Property, plant, and equipment, net $205,000
Patents 18,000
Inventory 122,000
Accounts receivable 35,000
Cash 25,000
Liabilities (55,000)
Fair value of net assets $350,000

Normally, differences between fair value and book value are more common among non-current assets than among current

assets. Cash obviously poses no problems as to value. Receivables normally are fairly close to current
valuation although they may at times need certain adjustments due to inadequate bad debt provisions.
Liabilities usually are stated at book value. However, if interest rates have changed since the company
incurred the liabilities, a different valuation (such as present value based on expected cash flows) is
appropriate. Careful analysis must be made to determine that no unrecorded liabilities are present.

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The $80,000 difference in Tractorling’s inventories ($122,000 - $42,000) could result from a number of
factors. The most likely is that the company uses the average-cost method. Recall that during periods of
inflation, average-cost will result in lower inventory valuations than FIFO.

In many cases, the values of non-current assets such as property, plant, and equipment and intangibles
may have increased substantially over the years. This difference could be due to inaccurate estimates of
useful lives, continual expensing of small expenditures (say, less than $300), inaccurate estimates of
residual values, and the discovery of some unrecorded assets. (For example, in Tractorling’s case,
analysis deter-mines Patents have a fair value of $18,000.) Or, fair values may have substantially
increased.

Since the investigation now determines the fair value of net assets to be $350,000, why would Feng pay
$400,000? Undoubtedly, Tractorling points to its established reputation, good credit rating, top
management team, well-trained employees, and so on. These factors make the value of the business
greater than $350,000. Feng places a premium on the future earning power of these attributes as well as
on the basic asset structure of the company today.

Feng labels the difference between the purchase price of $400,000 and the fair value of $350,000 as
goodwill. Goodwill is viewed as one or a group of unidentifiable values (intangible assets), the cost of
which “is measured by the difference between the cost of the group of assets or enterprise acquired and
the sum of the assigned costs of individual tangible and identifiable intangible assets acquired less
liabilities assumed.” This procedure for valuation is called a master valuation approach. It assumes
goodwill covers all the values that cannot be specifically identified with any identifiable tangible or
intangible asset. Illustration below shows this approach.

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 Feng records this transaction as follows:

Property, Plant, and

Equipment 205,000
Patents 18,000
Inventory 122,000
Accounts receivable 35,000
Cash 25,000
Goodwill 50,000
Liabilities 55,000
Cash 400,000
Companies often identify goodwill on the statement of financial position as the excess of cost over the
fair value of the net assets acquired.
Goodwill Write-Off
Companies that recognize goodwill in a business combination consider it to have an indefinite life and
therefore should not amortize it. Although goodwill may decrease in value over time, predicting the
actual life of goodwill and an appropriate pattern of amortization is extremely difficult. In addition,
investors find the amortization charge of little use in evaluating financial performance.

Furthermore, the investment community wants to know the amount invested in goodwill, which often is
the largest intangible asset on a company’s statement of financial position. Therefore, companies adjust
its carrying value only when goodwill is impaired. This approach significantly impacts the income
statements of some companies.

Some believe that goodwill’s value eventually disappears. Therefore, they argue, companies should
charge goodwill to expense over the periods affected, to better match expense with revenues. Others note
that the accounting treatment for purchased goodwill and goodwill created internally should be
consistent. They point out those companies immediately expense goodwill created internally and should

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follow the same treatment for purchased goodwill. Though these arguments may have some merit, non-
amortization of goodwill combined with an adequate impairment test should provide the most useful
financial information to the investment community. We discuss the accounting for goodwill impairments later in the chapter.
Bargain Purchase
In a few cases, the purchaser in a business combination pays less than the fair value of the identifiable net
assets. Such a situation is referred to as a bargain purchase. A bar-gain purchase results from a market
imperfection, that is, the seller would have been better off to sell the assets individually than in total.
However, situations do occur (e.g., a forced liquidation or distressed sale due to the death of a company
founder) in which the purchase price is less than the value of the net identifiable assets. This excess
amount is recorded as a gain by the purchaser.

The IASB notes that an economic gain is inherent in a bargain purchase. The purchaser is better off by
the amount by which the fair value of what is acquired exceeds the amount paid. Some expressed concern
that some companies may attempt inappropriate gain recognition by making an intentional error in
measurement of the assets or liabilities. As a result, the IASB requires companies to disclose the nature of
this gain transaction. Such disclosure will help users to better evaluate the quality of the earnings
reported.

8.5. Impairment of Intangible Assets

An intangible asset is impaired when a company is not able to recover the asset’s to determine whether
a long-lived asset (property, plant, and equipment or intangible assets) is impaired, a review is made of
the asset’s cash-generating ability through use or sale. If the carrying amount is higher than the
recoverable amount, the difference is an impairment loss. If the recoverable amount is greater than the
carrying amount, no impairment is recorded. The specific procedures for recording impairments depend
on the type of intangible asset—limited-life or indefinite-life (including goodwill).
Impairment of Limited-Life Intangibles
The rules that apply to impairments of property, plant, and equipment also apply to limited-life
intangibles. At each statement of financial position date, a company should review limited-life
intangibles for impairment. Information indicating that an impairment test should be performed might be
internal (e.g., physical damage or adverse changes in performance) or external (e.g., adverse changes in
the business or regulatory environment, or technological or competitive developments). If there is an
indication that an intangible asset is impaired, the company performs an impairment test: compare the
carrying value of the intangible asset to the recoverable amount.

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Recall that the recoverable amount is defined as the higher of fair value less costs to sell or value-in-use.
Fair value less costs to sell means what the asset could be sold for after deducting costs of disposal.
Value-in-use is the present value of cash flows expected from the future use and eventual sale of the asset
at the end of its useful life. The impairment loss is the carrying amount of the asset less the recoverable
amount of the impaired asset. As with other impairments, the loss is reported in profit or loss. Companies
generally report the loss in the “Other income and expense” section.

To illustrate, assume that Lerch, Inc. has a patent on how to extract oil from shale rock, with a carrying
value of 5,000,000 at the end of 2014. Unfortunately, several re-cent non-shale-oil discoveries adversely
affected the demand for shale-oil technology, indicating that the patent is impaired. Lerch determines the
recoverable amount for the patent, based on value-in-use (because there is no active market for the
patent). Lerch estimates the patent’s value-in-use at 2,000,000, based on the discounted expected net
future cash flows at its market rate of interest. Illustration below shows the impairment loss computation
(based on value-in-use).

Carrying value of patent €5,000,000

Recoverable amount (based on value-in-use) (2,000,000)

Loss on impairment €3,000,000

Lerch records this loss as follows:

Loss on Impairment 3,000,000
Patents 3,000,000
After recognizing the impairment, the recoverable amount of 2,000,000 is the new cost basis of the
patent. Lerch should amortize the patent’s recoverable amount (new carrying amount) over its remaining
useful life or legal life, whichever is shorter.
Reversal of Impairment Loss
What happens if a review in a future year indicates that an intangible asset is no longer impaired because
the recoverable amount of the asset is higher than the carrying amount? In that case, the impairment loss
may be reversed. To illustrate, continuing the Lerch patent example, assume that the remaining life of the
patent is five years with zero residual value. Recall the carrying value of the patent after impairment is
2,000,000 (5,000,000 - 3,000,000). Thus, Lerch’s amortization is 400,000 (2,000,000 / 5) over the
remaining five years of the patent’s life. The amortization expense and related carrying amount after the
impairment is shown in Illustration below:

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 Year Amortization Expense Carrying Amount
2015 400,000 1,600,000 (2,000,000 - 400,000)
2016 400,000 1,200,000 (1,600,000 - 400,000)
2017 400,000 800,000 (1,200,000 - 400,000)
2018 400,000 400,000 (800,000 - 400,000)
2019 400,000 0 (400,000 - 400,000)

Early in 2016, based on improving conditions in the market for shale-oil technology, Lerch
remeasures the recoverable amount of the patent to be 1,750,000. In this case, Lerch reverses a portion of
the recognized impairment loss with the following entry.
Patents (1,750,000 -1,600,000) 150,000
Recovery of Impairment Loss 150,000
The recovery of the impairment loss is reported in the “Other income and expense” section of the income
statement. The carrying amount of the patent is now 1,750,000 (1,600,000 + 150,000). Assuming the
remaining life of the patent is four years, Lerch records 437,500 (1,750,000 / 4) of amortization expense
in 2016.
Impairment of Goodwill
The timing of the impairment test for goodwill is the same as that for other indefinite-life intangibles.
That is, companies must test goodwill at least annually. However, because goodwill generates cash
flows only in combination with other assets, the impairment test is conducted based on the cash-
generating unit to which the goodwill is assigned. Under IFRS, when a company records goodwill in a
business combination, it must assign the goodwill to the cash-generating unit that is expected to benefit
from the synergies and other benefits arising from the business combination.

To illustrate, assume that Kohlbuy Corporation has three divisions. It purchased one division, Pritt
Products, four years ago for 2 million. Unfortunately, Pritt experienced operating losses over the last
three quarters. Kohlbuy management is now re-viewing the division (the cash-generating unit), for
purposes of its annual impairment testing. Illustration below lists the Pritt Division’s net assets, including
the associated goodwill of 900,000 from the purchase.

Property, plant, and equipment (net) 800,000

Goodwill 900,000
Inventory 700,000
Receivables 300,000
Cash 200,000
Accounts and notes payable (500,000)

Net assets 2,400,000

15
By Tefera B. (PhD Candidate)
Kohlbuy determines the recoverable amount for the Pritt Division to be €2,800,000, based on a value-in-
use estimate. Because the fair value of the division exceeds the carrying amount of the net assets,
Kohlbuy does not recognize any impairment.
However, if the recoverable amount for the Pritt Division were less than the carrying amount of the net
assets, then Kohlbuy must record impairment. To illustrate, assume that the recoverable amount for the
Pritt Division is €1,900,000 instead of €2,800,000. Illustration 12-11 computes the amount of the
impairment loss to be re-corded.
Recoverable amount of Pritt Division 1,900,000
Net identifiable assets (2,400,000)
Loss on impairment 500,000

Kohlbuy makes the following entry to record the impairment.

Loss on Impairment 500,000
Goodwill 500,000

Following this entry, the carrying value of the goodwill is 400,000.

If conditions change in subsequent periods, such that the recoverable amount of the Pritt Division’s assets
other than goodwill exceeds their carrying value, Kohlbuy may reverse an impairment loss on the Pritt
Division assets other than goodwill. Goodwill impairment loss reversals are not permitted.

16
By Tefera B. (PhD Candidate)