Problem No 15.

– Substantive audit procedures for intangible assets

Select the best answer of the following:

1. An auditor has set an audit objective of determining whether research and development
projects were properly authorized. Which of the following audit techniques will best meet
this objective?

a. Inquiry
b. Observation
c. Analytical review
d. Inspection of documents

2, An entity developed a new secret formula which is of great value because it resulted in a
virtual monopoly. The entity has capitalized all research and development costs associated
with this formula. The CPA who is examining this account, will probably
a. Confirm that the secret formula is registered and on file with the county clerk’s office.
b. Confer with management regarding a change in the title of the account to “goodwill”
c Confer with management regarding transfer of the amount from the statement of financial
position to the income statement..
d. Confer with management regarding ownership of the secret formula.

3.The most effective means for the auditor to determine whether a recorded intangible asset
possesses the characteristics of an asset is to
a. Evaluate the future revenue producing capacity of the intangible asset.
b. Analyze research and development expenditures for determine that only those expenditures
possessing future economic benefit have been capitalized.
c. Vouch the purchase by reference to underlying documentation.
d. Inquire as to the status of patent applications.

4. The auditee has just acquired another company by purchasing all its assets. As a result of
the purchase, “goodwill” has been recorded on the auditee’s books. Which of the following
comparisons would be the most appropriate audit test for the amount of recorded goodwill?
a. The purchase price and the book value of assets purchased
b. The figure for goodwill specified in the contract for purchase
c. Earnings in excess of 15% of net assets for the past five years
d. the purchase price and the fair market value of assets purchased

5. In verifying the amount of goodwill recorded by a client, the most convincing evidence
which an auditor can obtain is by comparing the recorded value of assets acquired with the
a. Assessed value as evidence by tax bills
b. Appraised value as evidenced by independent appraisals.
c. Seller’s book value as evidenced by financial statements
d. Insured value as evidence by insurance companies

6. In auditing intangible assets, an auditor most likely would review or recompute

amortization and determine whether the amortization period is reasonable in support of
management’s financial statement assertion of
a Completeness.
b. Valuation and allocation
c. Existence or occurrence
d. Right and obligations

7. There is goodwill involved in the acquisition of a business if the purchase price paid is in
excess of the proprietorship of the business acquired.

Goodwill might be viewed as the enjoyment of a profit by a company in excess of the normal
or usual return for the industry as a whole but such goodwill is not recorded if it has not been
purchased or paid for.
a False; True.
b. True; False
c. False; False
d. True; True

Problem No.16 – Impairment and revaluation of license

A license is acquired July 1, 2007, for P450,000; while it has a legal life of 15 years, due to
rapidly changing environment, management estimates a useful life of only 5 years. Straight-
line amortization will be used. At January 1, 2008, management estimated that the
recoverable amount of the license is only P135,000/ Amortization will be taken over 3 years
from that point.

On January 1, 2010, due to the change in general economic situations, the license now has a
fair value of P540,000. The entity adopted the revaluation model to measure the license
starting January 1, 2010. The estimated remaining useful life is now believed to be 5 years.

QUESTIONS:

1. How much is the loss on impairment on January 1, 2008?

a P270,000.
b.P300,000
c.P225,000
d.0

2. How much can be recognized as gain on impairment recovery in 2010?

a. P270,000
b.P180,000
c. P 495,000
d. P315,000

3. How much will be recognized as revaluation surplus on January 1, 2010?

a. P270,000
b.P180,000
c.P495,000
d.P315,000

Problem No.17 - Impairment of intangible assets

On December 31, 2009, Siniloan Corporation acquired the following three intangible assets:

A trademark for P450,000. The trademark has 7 years remaining legal life. It is anticipated
that the trademark will be renewed in the future, indefinitely, without problem.

Goodwill for P2,250,000. The goodwill is associated with Siniloan’s Laguna Manufacturing
reporting unit.

A customer list for P330,000. By contract, Siniloan has exclusive use of the list for 5 years.
Because of market conditions, it is expected that the list for 5 years. Because of market
conditions, it is expected that the list will have economic value for just 3 years.

On December 31, 2010, before any adjusting entries for the year were made, the following
information was assembled about each of the intangible assets:

a) Because of a decline in the company, the trademark is now expected to generate cash flows
of just P15,000 per year. The useful life of trademark still extends beyond the foreseeable
horizon.

b) The cash flows expected to be generated by the Laguna Manufacturing reporting unit is
P375,000 per year for the next 22 years. Carrying amounts and fair values of the assets and
liabilities of the Laguna Manufacturing reporting unit are as follows:

Carrying amount Fair values

Identifiable assets P4,050,000 P4,500,000
Goodwill 2,250,000 ?
Liabilities 2,700,000 2,700,000

c) The cash flows expected to be generated by the customer list are P180,000 in 2011 and
P120,000 in 2012.

QUESTIONS

Based on the above and the result of your audit, determine the following: (Assume that the
appropriate discount rate for all items is 6% Round off present value factors to 4 decimal
places):

1. Total amortization for the year 2010

a.P110,000
b.P174,285
c.P212,273
d.P130,285

2. Impairment loss for the year 2010

a. P135,714
b P269,376
c. P200,000
d. 0
3.Carrying amount of Trademark as of December 31, 2010
a. P450,000 b P250,000
c. P385,715 d. P180,624

4. Carrying amount of Goodwill as of December 31, 2010

a. P2,250,000 c. P2,147,727
b. P264,000 d. 0

5. Carrying amount of Customer list as December 31, 2010

a. P330,000 c.P220,000
b. P264,000 d.0

Problem No.18 - Software development expenditures

Pagsanjan Softbytes Corporation is engaged in developing computer software for the small
business at home computer market. Most of the computer programmers are involved in
developmental work designed to produce software that will perform fairly specific tasks in a
user friendly manner. Extensive testing of the working model is performed before it is
released to production for preparation of masters and further testing. As a result of careful
preparation, Pagsanjan has produced several products that have been very successful in the
market place. The following costs were incurred during 2010:

Salaries and wages of programmers doing research P940,000

Expenses related to projects prior to establishment of
technological feasibility 313,600
Expenses related to projects after technological
feasibility has been established but before software
is available for production 198,000
Amortization of capitalized software development cost
from current and prior years 107,000
Costs of produce and prepare software for sale 225,200

Additional data for 2010:

Sale of product for the year P2,060,000
Beginning inventory 568,000
Portion of goods available for sale during the year 60%

QUESTIONS:

1. Amount to be capitalized as software development cost subject to amortization

a. P1,451,600 c. P736,800
b. P198,000 d. 0

2. Cost of ending inventory

a. P270,000 c. P439,280
b. P317,280 d. P360,080

3. Total amount related to the development of computer software that should be expensed
when incurred

a. P1,253,600 c. P1,451,600
b. P940,000 d. 0
Problem No. 19 – Software development expenditures

Lumban Software Com[any is an established computer software company. In 2009, the firm
incurred the following costs in the process of designing, developing and producing a new
software program using a certain technology to access the internet.

Designing and planning P1,800,000

Code development 2,700,000
Testing 900,000
Production of product master 4,500,000

In 2010, Lumban incurred P1,800,000 in costs to produce the software program for sale in
2010. The costs of designing and planning, code development and testing were all incurred
before the technological feasibility of the product was established. Lumban began marketing
the software program in 2010 and earned revenues of P4,320,000 in 2010. Lumban estimates
that total revenues over the 4-year life of the product will be P21,600,000. At the end of
2010, Lumban was offered P7,200,000 for the rights to distribute the software.

QUESTIONS:

1. How much of the R and D and production cost will be expensed in 2009?
a P9,900,000. c.P6,300,000
b. P6,525,000 d. P5,400,000

2. How much of the R and D and production cost will be expensed in 2010?
a. P2,700,000 c. P1,575,000
b.P2,925,000 d. P1,260,000

Problem No.20 – Audit of patent

On January 2, 2002, Nagcarlan Company spent P480,000 to apply for and obtain a patent on
a newly developed product. The patent had an estimated useful life of 10 years. At the
beginning of 2007, the company purchased for P280,000 a patent that was expected to
prolong the life of its original patent by 5 years. On July 1, 2010, a competitor obtained rights
to a patent that made the company’s patent obsolete.

QUESTIONS:

1. Carrying amount of patent as of December 31, 2006

a. P360,000 c. P369,600
b. P240 d. P355,200

2. Amortization of patent in 2007

a. P64,000 c. P52,000
b. P64,960 d. P 63,520

3. Carrying amount of patents as of December 31, 2009

a. P448,000 c. P448,000
b. P416,000 d. P364,000

4. Loss on patent obsolescence in 2010

a. P338,000 c. P448,000
b. P416,000 d. P364,000

Problem No – 21 Internally generated patent

You gathered the following information related to the Patents account of the Majayjay
Cookie Corporation in connection with your audit of the company’s financial statements for
the year 2010.

In 2009, Majayjay developed a new machine that reduces the time required to insert the
fortunes into its fortune cookies. Because the process is considered very valuable to the
fortune cookie industry, Majayjay patented the Machine. The following expenses were
incurred in developing and patenting the machine:

Research and development laboratory expense P1,000,000

Metal used in the construction of the machine 320,000
Blueprints used to design the machine 128,000
Legal expenses to obtain patent 480,000
Wage 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) 1,200,000
Expense of drawing require by the patent office to be
submitted with the patent application 68,000
Fees paid to the government patent office to process
application 100,000

During 2010, Majayjay paid P150,000 in legal fees to successfully defend the patent against
an infringement suit by Cookie monster Corporation.

It is the company’s policy to take full year amortization in the year of acquisition.

QUESTIONS:

1. Cost of Patent
a. P580,000 c. P1,128,000
b. P648,000 d. P798,000

2. Cost of machine
a. P1,236,000 c.P1,040,000
b. P1,648,000 d. P1,168,000

3. Amount that should charged to expense when incurred connection with the development of
the patented machine
a. P1,480,000 c. P1,608,000
b P1,000,000. d. 0
4. Carrying amount of patent as December 31, 2010
a. P522,000 c. P1,015,200
b. P583,200 d. P837,900

Problem No.22 – Franchise,patent and trademark

You noted the following items relative to the company’s intangible assets in connection with
your audit of the Paete Corporation’s financial statements for the year 2010.

On January 1, 2010, Paete signed an agreement to operate as franchisee of Clear Copy

Service Inc.For an initial franchise of P680,000. Of this amount, P200,000 was paid when the
agreement was signed and balance was payable in four annual payments of P120,000 each,
beginning January 1, 2011. The agreement.

provides that the down payment is not refundable and no future services are required of the
franchisor. The implicit rate for loan of this type is 14%. The agreement also provides the
5%of the revenue from the franchise must be paid to the franchisor annually. Paete’s revenue
from the franchise for 2010 was P8,000,000. Paete estimates that the useful life of the
franchise to be ten years.

Paete incurred P624,000 of experimental and development costs in its laboratory to develop a
patent which was granted on January 2, 2010. Legal fees and another costs associated with
the registration of the patent totaled P131,200. Paete estimates that the useful life of the
patent will be eight years.

A trademark was purchased from Tsek Company for P320,000on July 1, 2007. Expenditures
for successful litigation in defense of the trademark totaling P80,000 were paid on July 1,
2010. Paete estimate that the trademark’s useful life will be indefinite.

QUESTIONS:

1. Total expenses related to franchise in 2010

a. P503,914 c. P448,950
b. P535,200 d.P454,964

2. Carrying amount of franchise as of December 31, 2010

a. P549,644 c. P538,733
b. P494,680 d. P612,000

3.Carrying amount of patent as of December 31, 2010

a. P131,200 c. P124,640
b. P114,800 d. P123,482

4. Carrying amount of trademark as of December 31, 2010

a. P320,000 c. P304,000
b. P288,000 d. P400,000

5. Carrying amount of intangible assets as of December 31, 2010

a P1,046,800. c. P1,009,480
b. P984,4444 d. P929,480
Problem No.23 – Audit of research and development expenditures

Presented below are five unrelated situations. For each situation compute the amount that will
be classified and expensed as research and development.

1. Mabitac Company uncured the following costs during 2010:

Quality control during commercial production,

including routine testing of products P460,000
Laboratory research aimed at discovery of new knowledge 540,000
Engineering follow-through in an early phase of
commercial production 120,000
Adaptation of existing capability to a particular
requirement or customer’s need as part of
continuing commercial activity 110,000
Trouble-shooting in connection with breakdowns
during commercial production 230,000
Searching for applications of new research findings 150,000

a P690,000. c. P1,150,000
b.P540,000 d. P1,610,000

2. Lumban Company incurred the following costs during 2010 in connection with its research
and development activities:

Cost of equipment acquired that will have

alternative uses in future research and
development projects over the next 5 years P1,400,000
Materials consumed in research and development
project 295,000
Consulting fees paid to outsiders for research and
development projects 500,000
Personnel costs of persons involved in research and
development projects 640,000
Indirect costs reasonably allocable to research and
development projects 250,000
Materials purchased for future research and development 170,000
a. P1,685,000 c. P1,465,000
b. P 2,135,000 d. P1,965,000

3. During 2010, Pangil Company incurred the following costs:

Research and development services performed by

Talim Company for Pangil P700,000
Testing for evaluation of new products 600,000
Laboratory research aimed at discovery of new
knowledge 850,000
a P1,450,000. c. P2,150,000
b.P850,000 d.P1,550,000
4. Rizal Company incurred the following costs during the year ended December 31, 2010:

Design, construction, and testing of preproduction

prototypes and model P435,000
Routine, on-going efforts to refine, enrich or
otherwise improve upon the qualities of an
existing product 375,000
Quality control during commercial production
including routine testing of products 450,000
Laboratory research aimed at discovery of new
knowledge 650,000
a. P630,000 c. P1,440,000
b. P1,065,000 d. P1,005,000

5.Victoria, Inc. incurred the following costs during the year ended December 31, 2010:

Laboratory research aimed at discovery of new

knowledge P300,000
Radical modification to the formulation of a
chemical product 217,500
Research and development costs reimbursable
under a contract to perform research and
development for Court Corporation 525,000
Testing for evaluation of new products 337,500
a. P855,000 c. P300,000
b. P1,380,000 d.P637,500

Problem No. 24 – Audit of goodwill

Presented below are five unrelated situations. For situation no. 1, compute for the normal
earnings for the purposes of computing goodwill. For situations 2 to 5, compute the amount
of goodwill.

1. Calauan Corporation’s pretax accounting income for the year 2010 was P1,275,000 and
included the following items:

Impairment of goodwill P90,000

Amortization of identifiable intangibles 85,5000
Depreciation on building 120,000
Loss from fire 66,000
Gain on sale of machinery 225,000
Profit-sharing payments to employees 97,500

Cavinti Corporation is planning to purchase Calauan Corporation. In attempting to measure

Calauan’s normal earnings for 2010, Cavinti determined that the fair value of the building is
triple the carrying amount and that the remaining economic life is double that used Calauan.
Cavinti would continue the profit-sharing payments to employees; such payments are based
on income before depreciation and amortization
a. P1,056,000 c. P1,146,000
b.P1,206,000 d.P966,000
2. On January 1, 2010, Alaminos Corporation purchased Bay Company by paying P500,000
cash and issuing a P200,000 note payable. At January 1, 2010, the statement of financial
position of Bay Company was as follows:

Cash P100,000 Accounts payable P400,000

Receivable 320,000 Bay, capital 470,000
Inventory 200,000 P870,000
Land 80,000
Building-net 150,000
Trademark 20,000__
P870,000
The recorded amounts all approximate current values except land (worth P120,000),
inventory (worth P250,000), and trademark (worthless)
a.P160,000 c. P30,000
b. P230,000 d.0

3. the net assets of Famy Company excluding goodwill totaled P2,400,000 and earnings for
the last 5 years totaled P2,670,000. Included in the latter figure are gain on sale of equipment
P225,000, typhoon loss of P120,000, and sales commissions of P45,000. In developing a
sales price for the industry, and the annual excess earnings are to be capitalized at 20% in
arriving at goodwill.
a. P885,000 c. P930,000
b.P990,000 d. P1,050,000

4. Kalayaan Corporation is considering acquiring Luisiana Company in total. Kalayaan

makes the following computations and conclusions:
The fair value of the identifiable assets of Luisiana Company is P3,600,000
The liabilities of Luisiana Company are P1,900,000
A fair estimate of the annual earnings for the indefinite future is P600,000 per year.
Considering the risk and potential of Luisiana Company, Kalayaan feels that it must earn a
25% return on its investment.
a. P175,000 c. P775,000
b. P700,000 d.P600,000

5. As the CEO of Magdalena Corporation, you are considering purchasing SP corporation,

whose statement of financial position is summarized below:

Current assets P1,500,000 Current liabilities P1,500,000

Fixed assets, net 3,500,000 Long-term debt 2,500,000
Other assets 1,500,000 Share capital 2,000,000
_______ Retained earnings 500,000
P6,500,000 P6,500,000
The fair value of current assets is P2,750,000 because of the undervaluation of inventory. The
normal rate of return on net assets for the industry is P15%. The average expected annual
earnings projected for SP Corporation is P700,000. Excess earnings method to compute the
estimated goodwill.
a. P1,089,465 c. P460,928
b. P1,380,800 d. P712,343

Problem No 25 – Patent, franchise, research and development

In connection with your audit of the Liliw Corporation’s financial statements for the year
2010 you noted the following items relative to the company’s intangible assets.

 A patent was purchased from Pansol Company for P4,000,000 on January 2, 2009.
Liliw estimated that the remaining useful life of the patient to be 10 years. The patent
was carried in Pansol’s accounting records at a carrying value of P4,000,000.when
Pansol sold it to liliw.
 During 2010, franchise was purchased from Makiling Company for P960,000. In
addition, 5% of the revenue from the franchise must be paid to makiling. revenue
from the franchise fro 2010 was P5,000,000. Liliw estimates the useful life of the
franchise to be 10 years and take full years amortization in the year of purchase.
 Liliw incurred research and development costs of P866,000 in 2010. Liliw estimates
that these costs will be recouped by Dece,ber 31, 2013
 On January 1, 2010, Liliw, because of the recent events in the industry, estimates that
the remaining life of the patent purchased on January 2, 2009, is only 5 years from
January 1, 2010.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Amortization of patent for 2010

a. P900,000 c. P720,000
b. P800,000 d. P400,000

2. Carrying amount of patent as of December 31, 2010

a. P2,880,000 c. P2,700,000
b. P2,400,000 d. P3,200,000

3. Carrying amount of intangible assets as of December 31, 2010

a. P3,264,000 c. P3,564,000
b. P4,610,000 d. P3,744,000

4. Total amount that should be charged against income in 2010

a P2,112,000. c. P2,012,000
b.P1,066,000 d. P1,932,000

Problem No 26 – Acquisition of intangible assets

\
Cavinti Company purchased a customer list and a formula for a total of P2,000,000. Cavinti
uses the expected cash flow approach for estimating the fair value of these two intangibles.
The appropriate interest rate is 8%. The potential future cash flows from the two intangibles,
and their associated probabilities, are a follows:

Customer List
Outcome 1 – 20% probability of cash flows of P250,000 at the end of each year for 5 years.
Outcome 2 – 30% probability of cash flows of P150,000 at the end of each year for 4 years
Outcome 3 – 500% probability of cash flows of P50,000 at the end of each year for 3 years
Formula
Outcome 1 – 10% probability of cash flows of P1,500,000 at the end of each year for 10
years
Outcome 2 – 20% probability of cash flows of P500,000 at the end of each year for 4 years
Outcome 3 – 70% probability of cash flows of P300,000 at the end of each year for 3 years

QUESTIONS:

1. The estimated fair value of the customer list is

a. P413,110 c.P106,697
b. P86,951 d.P541,284

2.The estimated fair value of the formula is

a. P4,164,771 c. P309,687
b. P1,878,915 d. P433,485

3.The cost to be allocated to the customer list is

a. P360,476 c. P230,037
b. P438,440 d. P395,042

4. The cost to be allocated to the formula is

a. P1,769,963 c. P1,561,560
b. P1,604,958 d. P1,639,524

Problem No 27 – Recognition and measurement of intangible and measure of intangible

assets

In connection with your audit of the Cabuyao Corporation, you noted the following
transactions during 2010:

Jan 2 Paid legal fees of P450,000 and stock certificate costs of P249,000 to complete
organization.

15 Hired a clown to stand in font of the corporate office for 2 weeks and hound
out pamphlets and candy to create goodwill for the new entity. Clown cost, P30,000;
pamphlets and candy, P15,000

Apr. 1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P1,287,000

Patent application and licensing fees 190,500
Total P1,477,500

It is estimated that in 6 years other companies will have developed improved

processes, making the Cabuyao Corporation process obsolete

May 1 Acquired both a license to use a special type of container and a distinctive trademark
to be printed on the container in exchange for 18,000 shares of Cabuyao’s no-par
ordinary shares selling for P50 per share. The license is worth twice as much as the
trademark, both of which may be used for 6 years.
July 1 Constructed a shed for P3,930,000 to house prototypes of experimental models to be
developed in future research projects
Dec.31 Incurred salaries for an engineer and chemist involved in product development
totaling P750,000 in 2010.

it is the company’s policy to take full year amortization in the year of acquisition.

QUESTIONS:

1. Cost of patent
a. P1,477,500 c. P1,287,000
b. P190,500 d.0

2. Cost of licenses
a.P450,000 c. P600,000
b.P300,000 d.0

3. Cost of trademark
a. P450,000 c. P600,000
b. P300,000 d.0

4. Carrying amount on Intangible Assets as of December 31, 2010

a. P2,031,250 c. P1,981,250
b. P2,026,250 d.0

5. Total amount resulting from the forgoing transactions that should be expensed when
incurred
a.P2,971,500 c. P5,424,000
b.P1,494,000 d.0

Problem No. 28 – Recognition of internally generated intangible assets

Alaminos Company has been involved in a project to develop an engine that runs on extracts
from sugarcane. It commenced the project in February 2010. Between the commencement
date and June 30,2010, there was no identification that the project would be commercially
feasible, although the company had made significant progress and was sufficiently sure of
future success that it was prepared to outplay more funds on the project.

After spending a further P1,800,000 during July and August, the company had built a
prototype that appeared to be successful. The prototype was demonstrated to a number of
engineering companies during September, and a number of these companies expressed
interest in the further development of the engine. Convinced that it now had a during October
adjusting for the problems that the engineering firms had pointed out. On November 1
Alaminos applied for the patent on the engine, incurring administrative costs of P525,000.
The patent had an expected useful life of five years.

Between November and December 2010, Alaminos spent an additional amount of P1,230,000
on engineering and consulting costs to develop the project such that the engine was at
manufacturing stage. These resulted in changes in the overall design of the engine, and costs
of P75,000 were incurred to add minor changes to the overall design of the patent authority.

On January 1, 2011, Alaminos invited tenders for the manufacture of the engine for
commercial sale.

QUESTIONS:

1. Total amount to be charge to expense when incurred

a.P7,185,000 c. P6585,000
b.P7,890,000 d. P8,415,000

2. Total amount to be recognized as Patent

a. P1,830,000 c. P525,000
b. P1,230,000 d. P 0

Problem No 29 - Items considered intangible assets

The following are items that could be included in the Intangible assets:

1. Investment in a subsidiary company. P1,500,000

2. Timberland 2,000,000
3. Cost of engineering activity required to advance the
design of a product to the manufacturing stage 120,000
4. Lease prepayments (6 months’ rent paid in advance) 60,000
5. Cost of equipment obtained under finance lease 700,000
6. Internally generated publishing title 230,000
7. Costs incurred in the formation of the corporation 90,000
8. Operating losses incurred in the start-up of the 560,000
business
9. Training costs incurred in start-up operations 80,000
10. Purchase of a franchise 1,200,000
11. Goodwill internally generated 300,000
12. Cost of testing in search for product alternatives 65,000
13. Goodwill acquired in the purchase of a business 640,000
14. Cost of developing a patent 140,000
15. Cost of purchasing a patent from an investor 500,000
16. Legal costs incurred in securing a patent 70,000
17. Costs of a successful legal suit to protect the patent 230,000
18. Cost of conceptual formulation of possible product
alternatives 160,000
19. Cost of purchasing a copyright 900,000
20. Research and development costs 340,000
21. Long-term receivables 310,000
22. Cost of developing a trademark 61,000
23. Cost of purchasing a trademark 290,000
24. computer software for a computer controlled machine
That cannot operate without that specific software 130,000
25. Operating system of a computer 10,000
QUESTION:

How much could be recognized as Intangible Assets?

a. P3,600,000 c. P5,830,000
b. P3,740,000 d. P3,530,000