CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 497

PROBLEM 6-1

Acquisition and Amortization of Intangible Assets

The INTANGIBLES COMPANY engaged in the following transactions

at the beginning of 2018:

i, Purchased a patent for P700,000 that had originally been fiied in

January_2012.~ The acquisition was made to protect another

patent that the company had filed for in January 2014 and
subsequently received.

2. Purchased the rights to a novel by a best-selling novelist in

exchange for 100,000 ordinary shares (P10 par) selling for P60
per share. The book sells 1 million copies in 2018 and is
expected to sell a total of 500,000 copies in future years.

3, Purchased the franchise to operate a ferry service from the

government for P100,000. A bridge has been planned to replace
the ferry, and it is expected that it will be completed in five years.
The company hopes that the ferry will continue as a tourist
attraction, but profits are expected to be only 20% of those
earned before the bridge is opened.

4. Paid P280,000 to attorneys for the services to successfully

defend the patent acquired in transaction 1. —_

5. Paid a taxi operator P500,000 to have the company name

prominently displayed on his taxis for two years.

Based on the preceding information, determine the carrying value of

the following at the end of 2018:

1. Patent
A. P630,000 C. _P910,000
B. P656,250 XD. P650,000
__ 4

—_ ———————
pAMMATON RENEW AUDITING PROR
498 mw LEMs CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 499
: 2. Copyright c. P3,000,000 PROBLEM 6-2
A. P2,000,000 D. P4,000,000 -
B. PO Acquisition and Amortization of Intangible Assets
3. Franchise ce’ P80,000 The following independent situations relate to the audit
of intangible
A. P100,000 4 , assets. Answer the question/s at the end of each situation.
D. P76,000
B. P84,000 an
Situation 1
6-1 YOLING INDUSTRIES reports the following patents on its December
See! SOLUTION 6- 31, 2017, statement of financial position.
— Date of Useful life
1. Cost of patent P700,000 Initi Acquisition iti
Amortization for 2018 (P700,000/14 years) —(50,000) PatentA . P1,224,000 March 1,
2014 17 years
Carrying value, December 31, 2018 P§50,000 Patent B 450,000 july 1, 2015 10 years
Answer: D : Patent C 432,000 Sept. 1, 2016 4 years
The cOmpeting patent purchased to_protect| another patent jw ther patent With a The
following events occurred during the year ended December 31,
life of 16 years has a remaining legal life of 14 years and should be 2018.
amortized over that period.
1. Research and development costs of P737,100 were incurred
; during the year. These costs were incurred prior to projects
2. Cost of copyright P6,000,000 achieving economic viability.
Amortization for 2018 .
(P6,000,000 x 1million/1.5 million) 4,000,00' 2, Patent D was purchased on July 1
for P855,000. It has a
Carrying value, December 31, 2018 P2,000.000 remaining life of 9 % years. ,
Answer: A , .
3. A possible impairment of Patent B's value may have occurred at

December 31, 2018. This is due to a significant reduction in the

demands for certain products protected by Patent B. The

3. Cost of franchise ; P100,000

ae for 2018 (P100,000/5) (20,000) company’s controller estimates the following
future cash flows
rrying value, December 31, 2018 P.80,000 . from Patent B.
Answer; C December 31, 2019 P60,000
: December 31, 2020 60,000

- December 31, 2021 60,000

soacumuraanvevr AUDITING PROBL Ey.

500

e used for these cash flows is

The appropriate discount rate to b

8%.

What is the total carrying value of Yoling’s patents on December

31, 2017?
A. P2,383,500 ¢. P2,106,000
B. P1,390,620 p. P1,573,500

2. What amount of impairment loss should be reported by Yoling

for the year ended December 31, 2018?
A. P137,880 c. P337,500
B. P292,500 D. P154,620

3, What is the total carrying value of Yoling’s patents on December

31, 2018? : ;
A. P1,969,080 C. P2,158,500
B. P2,020,620 D. P2,203,500

Situation 2

In your audit of the books of DIEHARD CORP. for the year ended
December 31, 2018, you found the following items in connection
with the company’s patents account. ‘

a) Diehard had spent P360,000 during the year ended December

b)

31, 2017, for research and development costs. This amount was
debited to its patents account.. The company’s cost records
disclose that it had spent a total of P424,500 for the research and
development of its patents, of which P64,500 spent in 2017 had
been debited to Research and Development Expense.

The patents were issued on July 1, 2017. In connection with the

issuance of the patents, the company incurred legal expenses of

P42,840, whi ‘
Expense. which were debited to Legal and Professional Fees

CHAPTER @ AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 501

On January 5, 2018, Diehard paid a retainer of P45,000 for legal

¢)
services in connection with a patent infringement sult brought
against it. Deferred Costs was charged for the amount.

d) In reply to your inquiry about the company’s liabilities as of

December 31, 2018, you received a letter from the company’s
legal counsel dated January 20, 2019, which indicated that a
settlement of the patent infringement suit had been arranged.
The plaintiff will drop the suit and release the company from all
future liabilities in exchange for P60,000. Additional lawyer's
fees were incurred amounting to P3,780.

4, The correcting journal entries (excluding amortization) on

December 31, 2018, would include net debit (credit) to

Legal and Professional

Patents Fees Expense
A. P(317,160) P108,780
B. (208,380) 0
C. (272,160) 63,780
D. (253,380) 45,000
Situation 3

As the recently appointed auditor for SUPERPOWER COMPANY, you

have been asked to examine selected accounts. Your audit client,
organized in 2017, has setup a single account for all intangible
assets. The following summary shows the debit entries that have

been recorded during 2018.

Jan. 2 ‘Purchased patent (8-year life) P870,000
April 5 Goodwill 720,000
June 30 Payment of 12 months’ rent on property :
leased by Superpower . 182,000
July 1 Purchased franchise with 10-year life;
jration date, July 1, 2028 900,000
expiration da’ July 312,000

Aug. 3

Payment for copyright (5-year life)

i .
4
a

munenive: AUDITING PROB

CPA MMM LEMs CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 503

502

Sept.1 Research and develapment costs related

tomatent (incurred prior to achieving

economic viability) —320.000

P3.304.000

5. What is the total carrying value of Superpower’s intangible

assets as of December 31, 2018?
A. P2,928,917 C. P2,927,705
B. P2,622,250 D. P2,713,250

SOLUTION 6-2

Situation 1
1, Patent A . ,
Initial cost P1,224,000
Amortization:
2014 (P1,224,000/17 x 10/12) P 60,000
2015-2017 (P1,224,000 x 3/17) 216,000 (276,000) P 948,000
Patent B :
Initial cost P450,000
Amortization:
2015 (P450,000/10 x 6/12) P22,500
2016-2017 (P450,000 x 2/10) _90,000 (112,500) 337,500

Initial
nitial cost
Amortization: Paes O08

sone cout x 4/12) P 36,000

P432,000 x %) 108.000. (144,000) __288,000
Total carrying value of patents, Dec, 31, 2017 P1.573,500
Answer: D .

2. Patent B
Carrying value, Dec, 31, 2017 00
Less: 2018 amortization (P450,000 x 1/10) oe
Camying value, Dec. 31, 2018 292,500

r -

Present value of future cash flows (P60,000 x 2.5770) 154,620

Impairment loss P13Z.880
Answer: A
3. Patent A
. Carrying value, Dec. 31, 2017 P948,000
Less: 2018 amortization (P1,224,000 x 1/17) 72,000 876,000
Patent 8 154,620
Patent C
Carrying value, Dec. 31, 2017 P288,000
Less: 2018 amortization (P432,000 x ¥%) 108,000 180,000
Patent D
Initial cost . P855,000
Less: 2018 amortization (P855,000/9.5 x 6/12) 45,000 __ 810,000
Total carrying value of patents, Dec. 31, 2018 P27020,620
Answer: B
Situation 2
4. Adjusting Journal Entries
December 31, 2018
a) Retained earnings . 360,000
Patents ' 360,000
b) = Patents
Retained earnings 44,840 42.840
c) Legal and professional fees expense 45,000
Deferred costs . ' 45.000
d) — Legal and professional fees expense 63.780
Liability for settlement of patent ,
infringement suit 60.00
Accrued attorney's fees en

Answer: A

’
acwouronesrone AUDITING PROBL Ey,

504
Situation 3 7870,000
* .
7 on Amortization (P870,000/8) 108,750 P 781,35
Goodwill 900,000 20,009
hi
ao pemortization (P900,000/ 10 x 6/12) me fon 855,000
Copyright 4
lest 4 mortization (P312,000/5 x 5/12) 26,000 2
Total carrying value, Dec. 31, 2018 ae
Answer: B
PROBLEM 6-3
Prepayments

The following situations are found in the records of the

KILIMANJARO, INC. in your audit of the company’s financial
statements for the year ended December 31, 2018.

1. December 1, 2018:

Advertising expense 72,000

Cash 72,000
Payment of 2019 advertising contract. i
2. Balance of Office supplies expense, Dec. 31, 2018 P45,000
Balance of Unused office supplies, Dec. 31, 2018 15,000
Inventory of office supplies, Dec. 31, 2018 22,500

3. June 2, 2018:

Prepaid insurance
Cash 54,000

Payment of one-year insurance

premium for inventory,

54,000

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 505

Balance of Factory supplies expense account,

Dec. 31, 2018 P69,000

Physical inventory of factory supplies,
Dec. 31, 2018 , 58,500

On May 1, 2018, a two-year subscription to the Industry Journal

in the amount of P14,400 was paid. Subscriptions expense was
charged for the entire amount.

Prepare the adjusting journal entries on December 31, 2018, based

on the situations described.

SOLUTION 6-3

ADJUSTING JOURNAL ENTRIES

December 31, 2018

1. Prepaid advertising
Advertising expense

2. Unused office supplies

Office supplies expense
° (P22,500 - P15,000)

3. Insurance expense
Prepaid Insurance
(P54,000 x 7/12)

4. Factory supplies inventory

Factory supplies expense

5. Prepaid subscriptions
Subscriptions expense
(P14,400 x 16/24)

72,000

7,500

31,500

58,500

72,000

7,500

31,500

58,500

9,600

ces ITI, ibaa

506 CPA ELAMIRATIOR amewtr, AUDITING PROBLEMsg

ROBLEM 6-4

P
Cost of Patent

oped a new machine that reduces the

ES devel : .
KENYA ENTERPRIS remicals used in one of its leadin

time required to mix the cl

products. Because the process Is |
company, Kenya patented the machine.

Kenya incurred the following expenses. in developing and patenting the

machine:

Research and development laboratory expenses P750,000

Materials used in the construction of the machine 240,000
Blueprints used to design the machine 96,000

360,000

Legal expenses to obtain patent

Wages 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) 900,000
. Expense of drawing required by the Patent Office
to be submitted wiih the patent application .

Fees paid to Patent Office to process application

51,000
75,000

One year later, Kenya Enterprises paid P525,000 in legal fees to

successfully defend a patent against an infringement suit by Gaya-
gaya Company.

1, What is the total cost of the patent?

A. P993,000 C. P564,000
B. P486,000 D. P126,000

2. What is the total cost of the new machine?

A. P1,362,000 C. P780,000
B. PO D. P876,000-

is considered very valuable to the.

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 507

3, What is the entry to record the legal fees paid for the successful
defense of the patent against the infringement sult?

A. Patents 525,000

Cash , 525,000
B. Legal fees expense 525,000 .

Cash : 525,000
c. Machinery 525,000

Cash ‘ 525,000
D. Amortization expense - Patents 525,000

Cash 525,000

SOLOTION 6-4

4. Legal expenses to obtain patent ‘ P360,000

Expense of drawing required by Patent Office
to be submitted with patent application 51,000
Fees paid to process patent application 73,000
Total cost of patent ‘ P486,000
Answer: B
2. Materials used in the construction of the machine P240,000
Blueprints used to design the machine 96,000
Wages paid for the employees’ work on the
construction of the machine (P900,000 x 60%) 540,000
Total cost of machine P876,000

Answer: D

3. The legal fees paid for the successful defense of the patent should
be expensed, not capitalized. This expenditure does not meet the
definition of and the recognition criteria for.an Intangible asset. The

entry to record the legal fees paid is:

Legal fees expense 525,000

Cash
Answer: B

525,000

ashe

ce
ee

ern mnATiO REVIEWER AUDITING PROBLEYs

508

— Identifying Intangible Asset;

juded in the general ledger of

lowing amounts are inc

nee C{IERITA PEAK CORPORATION at December 31, 2018:
D
Organization costs / t a
Trademarks 3 000
Patents 25,000
Discount on bonds payable 105,000
Deposits with advertising agency for ads to promote
goodwill of company : 30,000
Cost of equipment acquired for various research and
ee 320,000

developinent projects
Costs of developing a secret formula for a product that
d for at least 20 years 240,000

is expected to be markete
On the basis of the information above, what is the total amount of
intangible assets to be reported by Margherita Peak in its statement
of financial pysition at December 31, 2018?

A. P342,0C0 L, rd10,000

B, 270,260 D. P830,000

SOLUTION 6-5

Trademarks P 45,000

Patents 225,000

Total intangible assets 270,000

Answer: B

» Organization cost ; .
a ae a should be recognized as expense In the period It is

PROBLEM 6-6

509

CHAPTER 6 AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS

Discount on bonds payable should be reported as a contra accourit

to bonds payable.

e cost of equipment acquired for various rese

projects should be included in the property, plant, and

section.

Deposits with advertising a

company should be report
assets section. PAS 38 does not preclude
as an asset when payment for the delivery 0
been made in advance of the delivery of goods o'

services.

arch and development

equipment

gency for ads to promote goodwill of the

ed as prepaid advertising in the current
recognizing a prepayment
f goods or services has
r rendering of the

Patent
As a member of the audit team for the audit of RAS DASHEN
COMPANY's financial statements for the year ended December 31,
2018, you have been asked to examine selected accounts. The
controller for Ras Dashen mentions that there is only one account

(shown below) kept for intangible assets.

INTANGIBLE ASSETS
‘ Debit _Credit__ Balance
P 72,000 P 72,000

Feb, 1 Organization costs

Mar.15 Research and development

costs : 1,880,000 1,952,000

April 3 Legal costs to obtain patent 150,000 2,102,000
May 1 Payment of 12 months’ rent

on property leased by Ras

Dashen 240,000 2,342,000

June 15 Promotional expenses related

to start-up of business 414,000 2,756,000

Dec. 31 Unamortized bond discount

2,924,000

on bonds due Dec. 31, 2038 168,000

Dec. 31 Operating losses for first year 482,000 3,406,000

CPA EXAMKATION BEVTEWES: AUDITING PROBL EMs
510

n expenses to be reported jn

izatio
t of organ for the year ended December 31

noun
1. The ar tement

Dashen’s income sta

“_T C. P582,000
8 438, a5 p. P240,000
>. What is the carrying value of the fate at December 31, 2018
~ assuming that its useful lifé-is 10 years?
A. P150,000 c. P135,000
B, P138,750 D. PO

o be shown on Ras Dashen’s statement of

financial position at December 31, 2018, is

A. P16C,000 C. P80,000
B. P240,000 D. PO

3. The prepaid rent t

SOLUTION G-6

1. Crganiz2tiin costs » P 72,000

Promote. al expenses related to start-up of business 414,000

Total crgsnization expenses P486,000

er! B

2. Legal cost to obtain patent Pi50,000

Less: Amortization, April 3— Dec. 31

(P150,000/10 x 9/12) -_11,250

Balance, Dec, 31, 2018 P138,750

Answer: B

2. Prepaid rent, Dec..31, 2018 (P240,000 x 4*/17) P80,000

* Jan. 1, 2019 ~ May 1, 2019

Answer: C

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 511

PROBLEM 6-7

Lease Bonus and Leasehold Improvements

MERU, INC. leases an old building which it intends to improve and

use for administrative purposes. The company pays a bonus of
P100,000 to obtain the lease. Annual rental for the 10-year lease
period ts P160,000. No option to renew the lease or sight to
purchase the property is given by the lessor.

After obtaining the lease, improvements on the leased building are

made costing P400,000. The building has an estimated remaining
useful life of 19 years.

1. What is the annual cost (excluding depreciation) of this lease to

Meru, Inc.? .
A. P210,000
B, P200,000

C. P160,000
D. P170,000

2. What is the amount of annual depreciation (straight-line), if any,

should Meru, Inc. record? :

A. P40,000 C. P50,000
B. P30,000 D. PO

3. Whatis the entry to record the lease bonus paid at the inception
of the lease?

A. Rent expense 100,000

Cash 100,000

B. Prepaid rent 100,000

, Cash 100,000

C. Prepaid rent 90,000

Rent expense 10,000

Cash 100,000

D. Rent expense 90,000

Prepaid rent 10,000

Cash 100,000
prOUMMATONREIEMEE AUDITING PROR ~
512 LEMs CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 513
SOLUTION 6-7 SLITION 6-8
1, Annual rental P160,009 Legal fees in connection with organization of the company
P171,000 ;
"Amortization of lease bonus —10,099 Costs of meetings of incorporators to discuss
organizational ;
Annual cost of lease P170.009 activities 63,000
. Filing fee to incorporate ; _— 9,000
Answer: D . eenenks Total organizational expenses P243.000
2. Annual depreciation on leasehold improveme answee B
(P400,000/10 years) P40.009
A Improvements to leased office space prior to occupancy of P225,000
Answer. ’ should be classified as leasehold improvements.
3. Prepaid rent 100,000 :
Cash 0,000 PROBLEM 6-9
Answer: B ;
Accounting for Patent, Franchise, and R&D Costs
PROBLEM 6-8
CAMEROON CORP. has provided information on intangible assets as
Organization Costs follows:
; e A patent was purchased from Patintero Company for
ELGON COMPANY was organized in 2017 and began operations at . P6,000,000 on January
1, 2017. On the acquisition date, the
the beginning of 2018. The company provides landscaping services. patent was
estimated to have a useful life of 10 years. The
The following costs were incurred prior to the start of operations: patent had a
net book value of P6,000,000 when Patintero

sold it to Cameroon. !

Legal fees in connecti ith ization of the

8 ection With Organization o; © On February 1, 2018, a franchise was purchased from
the

company P171,000 . .
Improvements to leased office space prior to Franchisor Company for P1,440,000. The
contract which
occupancy . pare 225,000 runs for 20 years provides that 5% of revenue from the
Costs of meetings of incorporators to discuss franchise aa be Pa anansor: Revenue
from the
organizational activities 63,000 _ franchise for 2018 was P7,500,000.
Filing fee to incorporate __ 9,000 © The following research and development costs
were incurred
P468,000 by Cameroon in 2018:

What is the total amount of organization costs that should be Materials and
equipment P eee

reported in Elgon’s income statement? P ersonnel ,

a. Ee C. P180,000 tae aD

B. P468,000° D. P207,006
;puansTONRENEWEE AUDITING PRG
514 a BLEMs

n, on January 1, 2018, est;

f recent events, Cameroon, —

Serie remaining useful life of the pen purchased on January

2017, is only 5 years from January 1, 2018. .

On December 31, 2018, the carrying value of the patent shoyi

a P4,320,000 C. P1,680,000

B. P6,000,000 D. PO
The unamortized cost of the franchise at December 31, 201g

2.
should be
A. P999,000 C. P1,440,000
B.- P1,356,250 D. P1,374,000

3. How much should be charged against Cameroon's income for the

year ended December 31, 2018? :

A. P2,280,000 ‘ C. P2,820,000

B. P2,826,000 D. P1,725,000
4. An auditor will most likely obtain evidence regarding the
continuing validity and existence of the patent by obtaining a

written representation from

A. The Securities and Exchange Commission (SEC)

B. A patent attorney :

C. The patent inventor

D. The patent owner

SOLUTION 6-9

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 515

2. Acquisition cost of franchise purchased Feb. 1, 2018 P1,440,000

Less: Amortization (P1,440,000/20 years x 11/12) _—_ 66,000
Carrying value of franchise, Dec. 31, 2018 P1.374,000

Answer: D

PAS 38 provides that the depreciable amoiint of an intangible asset

that has a finite life should be allocated (amortized) on a
systematic basis over its useful life. Amortization begins when the
asset is available for use, i.e., when it is in the location and condition
necessary for it to be capable of operating in the manner intended
by management. On the other hard, an intangible asset with an

indefinite useful life should not be amortized but should be tested

for impairment by comparing its recoverable amount with its carrying

amount at least annually, and whenever there is an indication that

the intangible asset may be impaired.

3. Charges against 2018 income:

Amortization of patent (see no. 1) P1,080,000

Amortization of franchise (see no. 2) 66,000

Payment to franchisor (P7,500,000 x 5%) 375,000

Research and development costs - _1,299,000

Total , 2,820,000
Answer: C

4. A patent attorney

Answer: B

PROBLEM 6-10

Research and Development Costs

1. Acquisition cost of patent purchased

een Jan. 1, 2017. 6,000,000

2017 (P6,000,000/10 years) P 600,000 EMI KOUSSI CORP. has its own research
department. However, the
2018 (P6,000,000 - 600,000 = ’ company purchases patents from time to time. The
following is a
P5,400,000/5 years) summary of transactions involving patents now owned by the

Carrying value of patent, Dec . 1,680,000

. 31, 2018 company.

Answer: A t P4.320,000
=p

ussmumenseM: AUDITING PROBL p40

516

3, Emi Koussi spent a total of P459,099 ™

«During 2012 and Ces that was patented (Patent A) on Apri

developing a new pro

1, 2014; additional

incurred.

legal and other costs of P50,000 Were

é Inventor, an j
tent B) developed by Nonoy nvento
A patent (Patent F) ©7500 on December 1, 2015, on whic

was purchased for

date i had an estimated useful life of 12 % years.

During 2014, 2015, and 2016, research and development

activities cost P510,000. No additional patents resulted from

these activities.

A patent infringement suit brought by the company against a

competitor because of the manufacture of articles infringing on
Patent B was successfully prosecuted at a cost of P42,600, A
decision in the case was rendered in June 2016.

On July 1, 2017, Patent C was purchased for P172,800. This

patent had 16 years yet to run.

During 2018, Emi Koussi expended P180,000 on patent

development. However, the company is still undecided as to how
the patent, if approved by the Bureau of Patents, will generate
probable future economic benefits.

Assume that the legal life of each patent is also its useful life.

1.

What is Patent A’s carrying value on December 31, 2018?

A. P120,888 C. P38,125
B. P497,125 D. P388,113
- What is Patent B’s carrying value on December 31, 2018?
A. P141,250 C. P32,092
B. P28,906 D. P173,342

a C's carrying value on December 31, 2018?

B. P327,600 : pee
CHAPTER G aupit oF PREPAYMENTS AND INTANGIBLE ASSETS

517

4. What is the total patent amortization expense to be reported in

Emi Koussi's income statement for the year ended December 31,

2018?
A. P37,300 C. P74,325
B. P28,741 D. P28,300

SOLUTION 6-10

Annual
Date Patent Cost Useful Life
April 1, 2014 A P50,000 20* years P 2,500
Dec. 1, 2015 Bo 187,500 © 12.5 years 15,000
July 1, 2017 C (172,800 16 years _10,800
P410,300 P28,300

* According to RA 8293, the Intellectual Property Code of the Philippines,

the term (legal life) of patert is 20 years from the date of filing the

application.
1. Cost of Patent A

Less: Amortization, April 1, 2014 — Dec. 31, 2018

(P2;500 x 4 9/12)
Carrying value, Dec. 31, 2018

Answer: C

2. Cost of Patent B

Less: Amortization, Dec. 1, 2015- Dec. 31, 2018

(P15,000 x 3 1/12)
Carrying value, Dec. 31, 2018

Answer: A
3. Cost of Patent C

Less: Amortization, July 1, 2017 — Dec. 31, 2018

(P10,800 x 1 6/12)
Carrying value, Dec. 31, 2018

Answer: D

P50,000

—1L875
P38.125

P187,500
pe
ORY

3 mounurenemerte AUDITING PROBLEM

51

for the year ended

amortization of patents for
8 eee. 31, 2018 (see schedule) F28.300

Answer: D

rosecuting oF defending a patent are

rather than enhancing the origina)
pected to flow from the patent,
pensed, not capitalized,

Legal costs incurred in pro

subsequent costs of maintaining,
future economic benefits that are a .
These subsequent legal costs should

preslem 6-11 ;
Patent Amortization

ANDES CORPORATION expended P510,000 in research and

development costs. These activities resulted to a new product called
the Dido Organ. It was patented at additional legal and other costs of
P54,000. The patent application was filed on October 1, 2014, and
the patent was estimated to have a useful life of 10 years.

On June 1, 2016, Andes spent P28,440 to successfully prosecute a

patent infringement. In addition, the patent's estimated useful life
was extended to 12 years from June 1, 2016. At the beginning of
2018, Andes determined that a competitor's product would make the
Oido Organ obsolete and the patent worthless by December 31,
2019. : :

Based on the preceding information, calculate the patent

amortization expense for each of the following years:

1. 2014
A. P14,100 C, P5,40
B. P12,750 D. a
2. 2015
A. P51,000
a
B Fab Ae D. ean

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 519

3. 2016
A. P4,438 C. P3,750
B, P2,188 D. P5,820
4. 2017 :
A. P4,438 C. P3,750
B. P6,120 . D. P2,188
5. 2018
A. P31,875 C. P39,062
B. P19,531 D, P3,750
SOLUTION 6-11
PATENT AMORTIZATION FOR 2014:
Oct. 1 — Dec. 31 (P54,000/10 x 3/12) P4350
Answer: D :
PATENT AMORTIZATION FOR 2015:
Jan, 1 ~ Dec. 31 (P54,000/10) P5.400
Answer: D
NT 16:
Cost of patent P 54,000
Less: Amortization, Oct. 1, 2014 — June 1, 2016:
: (P54,000/10 x 1 8/12) 9,000
Unamortized cost, June 1, 2016 P 45,000
Revised remaining life +12 yrs
. Revised annual amortization P3750
Amortization for 2016:
Jan. 1 - June 1 (P54,000/10 x 5/12) P2,250
June 1 — Dec. 31 (P3,750 x 7/12) 2,188
Total P4.438
Answer: A
wneuaent: AUDITING PROBLEMs

520 cra eu
Ls
TION FOR 201
4, PATENT AMORTIZATION FOR £°U%
(P45,000/12 years) . P3.750
Answer: C
5. B TIZATI R 2018: ssncon
| 000
Cost of patent ;
Less: Amortization: p1,350
2014 5/400
7016 | 41438
2017 3,750 14,938
Unamortized cost, Jan. 1, 2018 P 39,062
Revised remaining life 2 years

Revised annual amortization

Answer: B

PROBLEM 6-12
Research and Development Costs

The following costs were incurred by EVEREST COMPANY during

2078:
Searching for applications of new research findings
Trouble-shooting in connection with breakdowns during
commercial production 87,000
Adaptation of an existing capability to a particular
requirement or customer's need as a part of continuing

P 57,000

commercial activity 39,000

Engineering follow-through in an early phase of

commercial production 45,000

Radical modification of the formulation ofa glassware

product ‘ 78,000

Laboratory research aimed at discovery of new knowledge 204,000

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 521

Testing for evaluation of new products 72,000
Quality control during commercial production, including

routine testing of products 174,000

Materials consumed in research and development projects 177,000
Consulting fees paid to outsiders for research and

development projects 300,000

Personnel costs of persons involved in research and

development projects 384,000

Indirect costs reasonably allocable to research and
development projects 150,000
Materials purchased for future research and development

projects 102,000
Research and development costs reimbursable under a

contract to perform research and development for

Client Corporation 1,050,000

Design, construction, and testing of preproduction

prototypes and models 870,000

Routine on-going efforts to refine, enrich, or otherwise

improve upon the qualities of an existing product 730,000

Toth P4.539.000

What is the total amount to be classified and expensed as research

and development for 2018?
A. P3,342,000
B. P2,292,000

SOLUTION 6-12

C. P2,394,000
D. P2,220,000

Research and development expense for 2018:

Searching for applications of new research findings P 57,000

Radical modification of the formulation of a glassware
product / 78,000
CoA AMINATION REVIEWER AUDITING PROBLEMg

522

Laboratory research aimed at ascovery of new monies 70400

meres x evalua earch and developer’ projects 177'009
Consulting fees paid to outsiders for resear 5000

development prover nvolved in research and

Personnel costs of persons i 384,00

development projects ’
inclines costs reasonably allocable to research and iso sco
development projects F

Design, construction, and testing of pre-production ava

prototypes and models __870,000
Total
Answer: B

PAS 38 classifies the generation of an intangible asset into:

a) aresearch phase, and

b) a development phase.

relates to research activities should not be

recognized because the entity cannot demonstrate that an intangible

asset exists that will generate probable future economic benefits.

Therefore, such expenditure is expensed when it is incurred.

An intangible asset that

Examples of research activities are:

1. activities aimed at obtaining new knowledge;

2. the search for, evaluation, and final selection of applications of

research findings or other knowledge;

3. the search for alternatives ‘for materials, devices, products,

processes, systems or services; and , ‘

4. the formulation, design, evaluation, and final selection of possible

alternatives for new or improved materials, devices, products,

processes, systems or services.

An intangible asset that arises from the d

recogni ° evelopment phase shall be
nized if, and only if, an entity can demonstrate all of the following:

>, _————
CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 523

a) the technical feasibility of completing the intangible asset so that it

will be available for use or sale;

b) its intention to complete the intangible asset and use or sell it;
c) its ability to use or sell the intangible asset,

d) how the intangible asset will generate probable future economic

benefits (for example, the entity must be able to demonstrate the
existence of a market for the intangible asset or its output or, if it is
to be used internally, the usefulness of the intangible asset),

the availability of adequate technical, financial, and other resources

to complete the development and to use or sell the intangible asset;

and

e)

f) its ability to measure reliably the expenditure attributable to the

intangible asset during its development.

Examples of development activities are:

4. the design, construction, and testing of pre-production or pre-use

prototypes and models;

2, the design of tools, jigs, moulds, and dies.involving new technology;

3. the design, construction, and operation of a pilot plant that is not of

a scale economically feasible for commercial production; and

4. the design, construction, and testing a chosen alternative for new or

improved materials, devices, products, processes, systems or

services.

PROBLEM 6-13
Cost of Internally Generated Intangible Asset

MOSES COMPANY’s own research department has an on-going

project to develop a new production process. At the end of 2017,

DITI ‘
524 ek LAMINATION REVIEWERE AU NG PROBLEM

1 of P300,000, of which P270,000 w,.

d already spent a tota as

Meered hefore November 1, 2017. Ga Piasiener Bs 2017, the
ug newly developed production process met the criteria for

recognition as an intangible

‘ itional expenditure of P600,000

ing 2018, Moses incurred additiona 000. At

the end of 2018, the recoverable amount of the intangible asset Was
including future cash outflows to

estimated to be P570,000, re
complete the process before itis available for its intended use.

asset,

At December 31, 2017, the production process should be

1.
recognized at a cost of
A. P300,000 c. P30,000
B. PO D. P270,000
2. What is the total cost of the production process at December 31,
2018?
A. P630,000 C. P870,000
B. P600,000 D. P900,000

3. How much impairment loss should be recognized by Moses in

2018, in connection with the new production process?

A. P300,000 C. P30,000
B. PO D. P60,000

SOLUTION 6-13

1. Cost of the production process at Dec. 31, 2017

(P300,000 — P270,000)

Answer: C

P30,000

PAS 38 provides that the cost of an internally generated intangible

asset is the sum of expenditures incurred from the date when the
intangible asset first meets the recognition criteria. The standar
Prohibits recognition as part of the cost of an intangible asset at @

525

CHAPTER 6 aupit oF PREPAYMENTS AND INTANGIBLE ASSETS

later date, the expenditure that was initially recognized as an
expense when it was incurred.

2. Expenditure incurred:
From November 1, 2015 — December 31, 2017

(P300,000 — P270,000) P 30,000

During 2018 600,000

Total as of December 31, 2018 P630,000

Answer: A

3, Carrying amount as of December 31, 2018 (see no. 2) P630,000

Recoverable value 570,000

P. 60,000

Impairment loss
Answer: D

PROBLEM 6-14
Acquisition and Amortization of Intangible Assets

KIKIKTAT CORPORATION was organized in 2017. Its accounting

records include only one account for all intangible assets. The
following is a summary of the debit entries that have been recorded

and posted during 2017 and 2018:

. INTANGIBLE ASSETS

July1,2017 8-year franchise; expires June 30,2024 P126,000

Oct. 1,2017 Advance payment on leasehold (term of

lease is 2 years) 84,000

Dec. 31, 2017 Net loss for 2017 including incorporation

fee, P3,000, and related legal fees of

organizing, P15,000 (all fees incurred

in 2017) 48,000
Jan.2,2018 Acquired patent (10-year life) 222,000
Mar. 1, 2018 Cost of developing a secret formula 225,000

a
yronnevivi: AUDITING PROBLEy¢

cen Baul
526
’ hased 835,200
41.2018 Goodwill pur¢ .
nen Legal fee for successful defense of patent
=“ purchased above 37,950
osts 480,000

Oct.1,2018 Rese

Ignore income tax €

ds

arch and development c

ffects.
cember 31, 2018, should be

ized patent cost at De

The unamoriad pate 2222000
B. P235,440 p. P197,490
The unamortized franchise cost at December 31, 2018, should be
A. P110,250 C, P102,375
B. P94,500 D. P118,125

The amount of prepaid rent to be reported in Kikiktat’s

December 31, 2018, statement of financial position is

A. P73,500 C. P84,000
B. P31,500 D. P63,000

The adjusting entries on December 31, 2018, should fnclude a

net debit to the retained earnings account of

A. P889,275 C. P60,375
B. P42,000 D. P66,375 .

As a result of the adjustments at December 31, 2018, the total

charges against Kikiktat’s 2018 income should be

A. P840,900 C. P597,900

B. P822,900 D. P841,275 |

SOLUTION 6-14,

1. Cost of patent, Jan. 2, 2018 P222,000

: Amortization for 2018 (P222,000/10 years 2
Unamortized patent cost, Dec. 31, as years) p199,800

Answer: A

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 527

2, Cost of \ranchise, July 1, 2017 P126,000
Less: Amortization, July 1, 2017 — Dec. 31, 2018
(P126,000/8 x 1 6/12) 23,625
Unamortized franchise cost, Dec. 31, 2018 P102,375
Answer: C
3, Prepaid rent, Dec. 31, 2018 (P84,000 x 9/24) P31,500
Answer: B

4. ADJUSTING ENTRIES

December 31, 2018

a. Franchises 126,000
Prepaid rent 84,000
Retained earnings 48,000
Patents 222,000

Research and development expense

(P225,000 + P480,000) 705,000
Goodwill 835,200
Legal fees expense 37,950

2,058,150

Intangible assets

b. Franchise amortization expense (P126,000/8) 15,750

Retained earnings (P126,000/8 x 6/12) 7,875

Franchises 23,625

c. Rent expense (P84,000/2 years) 42,000

Retained earnings (P84,000 x 3/24) 10,500

Prepaid rent 52,500

d. Patent amortization expense 22,200

Patents 22,200
(P222,000/10 years)

Net debit to retained earnings

(P48,000 + P7,875 + P10,500) P66,375

Answer: D
moMmuTMAEEHR AUDITING PROBL Rye

528

5. Charges against 2018 income:

Research and development expense P705,009
Legal fees expense 37/950
Franchise amortization expense 38759
Rent expense ‘000
Patent amortization expense
Total —22,200

Answer: B 200

PROBLEM 6-15

Patent Acquisition and Amortization

KIJIK LABORATORIES holds a valuable patent (No. 362436) on a

device that burns body fats. Kijik does not manufacture or sell the
products and processes it develops; it conducts research and
develops products and processes which it patents, and then assigns
the patents to manufacturers on a royalty basis. The history of
Patent No. 362436 is as follows:

DATE ACTIVITY COST

2008-2009 Research conducted to develop device P7,680,000
2010 ‘

Jan. 5 Design and construction ofa prototype —‘1,752,000

Mar.15 _ Testing of models 840,000
2011
Jan. 2 Legal and other fees to process patent

application 1,241,000
2012
Dec. 10 Legal fees paid to successfully defend

device patent 714,000

2013
April 3 Research aimed at modifying the

design of the patented device 860,000

———— _,

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 529

2017
July 28 Legal fees paid in a successful patent

infringement suit against a competitor 680,000

A 17-year useful life was assumed by Kijik when it received the

initial device patent.

On January 1, 2016, it revised its useful life estimate downward to 5

remaining years.
The company’s reporting date is December 31, 2018.

Based on the preceding information, compute the carrying value of

Patent No. 362436 on each of the following dates:

1. December 31, 2011

A. P1,168,000 C. P1,241,000

B. P3,607,529 D. P1,178,950
2. December 31, 2015

A. P1,488,000 C. P350,400

B. P876,000 D. P817,600
3. December 31, 2018

A. P657,000 C. P525,600

B. P876,000 D. P350,400

SOLUTION 6-15

1. Cost to obtain patent, Jan. 2, 2011 P1,241,000

Less: 2009 amortization (P1,241,000/17 years) ___73,000
Carrying value, Dec. 31, 2011 P1.168,000

Answer: A
te

a ee

CPA ExAMIRATION REVIEMER: AUDITING PROBLEM

530
P1,168 0
31, 2011 168,009
Carrying value, Dec. 207
2 Less: Amortization, 2012 2015 seo
**” (p73,000 x 4 years) 232.0
Carrying value, Dec. 31,
Answer: B 8.009
, 2015 P876,009

2
3. Carving value, Dec. 31
Less: Amortization, 2016 - 201
Carrying value, Dec. 31, 2018

Answer: D

PROBLEM 6-16

8 (P876,000 x 3/5) 525,600

P350.400

‘Accounting for Various Intangible Assets

ACADIA CORP. was incorporated on January 2, 2017. The

corporation's financial statements for its first year’s operations were
not examined by a CPA. You have been engaged to audit the financial
statements for the year endéd December 31, 2018, and your audit is
substantially completed. The corporation's trial balance appears
below.

Acadia Corp.
TRIAL BALANCE
December 31, 2018
Debit Credit
Cash P 300,000
Accounts receivable : 1,460,000
Allowance for doubtful accounts P 29,200
Inventories 1,004,000
Machinery and equipment 2,380,000
zest depreciation 524,000
atents
; 2,564,00
Leasehold improvements 600 a
Prepaid expenses 900,000

———— searonenngpanii

CHAPTER © AUDIT OR PREPAYMENTS AND INTANGIBLE ASSETS 531

Goodwill 600,000
Licensing agreement No. 1 1,200,000
Licensing agreement No. 2 1,120,000
Accounts payable 1,460,000
Unearned revenue 345,600
Share capital , 6,000,000
Retained earnings, January 1, 2018 3,181,200
Sales 14,400,000
Cost of goods sold 9,500,000
Selling and administrative expenses 3,722,000
Interest expense 190,000
Loss on extinguishments of debt 400,000
Totals P25.240.000 25,940,000

The following information relates to accounts that may yet

require adjustment.

4. Patents for Acadia’s manufacturing process were acquired

January 2, 2018, at a cost of P1,870,000. An additional P694,000

was spent on December 29, 2018, to improve machinery covered

_ by the patents and charged to the Patents account. Depreciation

on property, plant, and equipment has been properly recorded

for 2018. Acadia uses the straight-line method for all
depreciation and amortization and the legal life on its patents.

On January 3, 2017, Acadia purchased Licensing Agreement No.

1, which was believed to have an indefinite useful life. The
balance in the Licensing Agreement No. 1 account includes its
purchase price of P1,140,000 and expenses of P60,000 related to
the.acquisition. On January 1, 2018, Acadia purchases Licensing
Agreement No. 2, which has a life expectancy of 10 years. The
balance in the Licensing Agreement No. 2 account includes its
P1,080,000 purchase price and P120,000 in acquisition
expenses, but it has been reduced by a credit of P80,000 for the
advance collection of 2019 revenue from the agreement.
——_—_———— eee

”~
a

ek EIANINATION REVIEWER: AUDITING PROBLEMg .

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 533

532

n explosion caused a permanent

roducing value of Licensing
9, a flood caused additional

In late December 2017, 4

jon in the expected revenue-P)

sareeuet? 1, and in January 201

Agreement No. agreement worthless. Th

that rendered the ig °

dam aee le amount of Licensing Agree No. 1 was
determined to be p480,000 at December 31, .

n the Goodwill account represents amount paid on

for a four-year advertising program,
asing Acadia’s sales.

3. The balance i
December 30, 2017,
estimated to assist in incre

4. The Leasehold Improvements account includes (a) the P360,000

cost of improvements with a total estimated useful life of 12
years, which Acadia as tenant made to leased premises in
January 2017, and movable assembly line equipment costing
P300,000 that was installed in the leased premises in December
2018. Acadia paid its rent in full during 2018. A 10-year non-
renewable lease was signed January 3, 2017, for the leased
building that Acadia used in manufacturing operations.

Prepare the adjusting journal entries that should be made on

December 31, 2018, Use a separate account for the accumulation of
each type of amortization.

SOLUTION 6-16

Acadia Corp.
ADJUSTING JOURNAL ENTRIES
December 31, 2018

a. Riaennery 694,000
To reclassify the cost of

improving machinery to the

Machinery account.
2. Cost of goods sold (Patent amortization) 93,500

Accumulated amortization - Patents 93,500

To record 2018 amortization of

patent. (P1,870,000/20 years)

Licensing agreement No. 2 80,000

Unearned revenue '
To recognize unearned revenue
for the advance collection of 2019
revenue from the agreement.

80,000

Retained earnings ‘ 720,000

Licensing agreement No. 1 720,000
To record the impairment in value of
Licensing Agreement No. 1.

Cost of Licensing Agreement No. 1 P1,200,000

Recoverable value 480,000
Impairment loss in 2017 B_ 720,000

Cost of goods sold

(Licensing agreement amortization) 120,000
Accumulated amortization —
Licensing Agreement No. 2 120,000
To record 2018 amortization of
Licensing Agreement No. 2.
(P1,080,000 + P120,000 = P1,200,000/10 = P120,000)

Prepaid expenses (P600,000 x 34) 450,009

Selling and administrative expenses
(P600,000 x ¥s) 150,000
Goodwill _ 600,000

To reclassify prepaid advertising

expense improperly charged to goodwill,
era CLAMIMATION REVIEWER AUDITING PROBLEMs

534
300,000
7. Machinery and equipment Y soo
Leasehold improvements ,000
To reciassit t of equipment 1s
charged to leasehold improvements.
i 0) 30,000
_ Retained earnings (P300,000/1
° ost of goods sold (7300,000/30) 30,000
: lated depreciation —
Accumula p sao

Leasehold improvements
To record 2017 and 2018 depreciation

on leasehold impro vements.

PROBLEM 6-17
Patents and R&D Costs

During 2016, APEX COMPANY purchased a building site for its

proposed research and development laboratory at a cost of
P1,200,000. Construction of the building was started in 2016. The
building was completed on December 31, 2017, at a cost of
P5,600,000 and was placed in service on January 2, 2018. The
estimated useful life of the building for depreciation purposes was
20 years; the straight-line method of depreciation was to be
employed and there was no estimated salvage value.

Management estimates that about 50% of the projects of the

research and development group will result in long-term benefits
(ie., at least 10 years) to the corporation. However, Apex fails to
demonstrate how such projects will generate probable future
economic benefits. The remaining projects either benefit the current
period or are abandoned before completion. A summary of the
amb of projects and the direct costs incurred in conjunction with
e research and development activities for 2018 appears below.

535

CHAPTER 6 AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS

ch and development group, Apex

nufacturing rights at a cost of
d on April 1, 2017, and has an

Upon recommendation of the resear

Company acquired a patent for ma
P1,600,000. The patent was acquire
economic life of 10 years.

Salaries and Other Expenses

Number Employee (excluding Building
ofProjects Benefits
Completed projects with
long-term benefits 30 ~=— P1,800,000 P1,000,000
Abandoned projects or
projects that benefit the
20 1,300,000 300,000

current period

Projects in process -

results indeterminate 19
Total 60 3,900,000 P1.540,000

1, The total research and development expenses for 2018 should be

A. P2,920,000 C. P5,440,000
B. P5,880,000 D. P5,720,000
2. What is the amount of patent amortization for 2018?
A. P80,000 C. P120,000
B. P160,000, D. PO

3. What is the book value of the building on December 31, 2018?

A. P5,320,000 C. P5,040,000
B. P5,600,000 D. P6,460,000

4. What is the carrying value of the patent at December 31, 2018?

A. P1,280,000 C. P1,600,000
B. P1,320,000 D. PO
ao

cpa COMMATION amet, AUDITING PROBLEMg

536
soLeTigN 6-17
P3,900,000
i d employee benefits i
" speciation or tang (P5,600,000/20 years) 20.0
Other expenses nses 1,540,000
Total research and development expe

Answer: D

2. Patent amortization for 2018 (P1,600,000/ 10 years) P160.000

Answer: B
3. Cost of building P5,600,000
Less: Accumulated depreciation, Dec, 31, 2018
(P5,600,000/29 years) 280.0
Book value, Dec. 31, 2018 P5.320,000
Answer: A
4. Cost of patent purchased April 1, 2017 P1,600,000
less: Amortization:
April 1 - Dec. 31, 2017
(P1,600,000/10 x 9/12) P120,000
Jan. 1 - Dec. 31, 2018
(P1,600,000/10) 160,000 280,000
Carrying value, Dec. 31, 2018 P1.320,000
Answer: B

PROBLEM 6-18

Acquisition and Amortization of Various Intangible Assets

me following information pertains to BAKER COMPANY’s intangible

CHAPTER 6 AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS

537

On January 1, 2019, Baker signed an agreement to operate as a

franchisee of Max & Jess Food Chain, Inc. for an initial franchise
fee of P1,500,000. Of this amount, P300,000 was paid when the
agreement was signed and the balance is payable in 4 annual
payments of P300,000 each, beginning January 1, 2019. The
agreement provides that the down payment is not refundable
and no future services are required of the franchisor. The
present value at January 1, 2018, of the 4 annual payments
discounted at 14% (the implicit rate for a loan of this type) is
P874,000. The agreement also provides that 5% of the revenue
from the franchise must be paid to the franchisor annually.
Baker’s revenue from the franchise for 2018 was P19,000,000.
Baker estimates the useful life of the franchise to be 10 years.

Baker incurred P1,300,000 of experimental and development

costs in its laboratory to develop a patent which was granted on
January 2, 2018. Legal fees and other costs associated with
registration of the patent totaled P272,000. Baker estimates that
the useful life of the patent will be 8 years.

. A trademark was purchased from Banawe Company for

P640,000 on July 1, 2015. Expenditures for successful litigation

in defense of the trademark totaling P163,200 were paid on July
1, 2017. Baker estimates that the useful life of the trademark
will be 20 years from the date of acquisition.

. What is the carrving value of the franchise at December 31,

2018?
A. P1,350,000 C. P1,056,600
B. P1,500,000 D, P1,174,000

What is the carrying value of the patent at December 31, 2018?

A. P238,000 C. P1,375,500

B. P272,000 D. P258,400
—

PA EXAMINATION enews: AUDITING PROBL Ey 5

538
demark on December
‘ng value of the tra at
3, What is the carrying
‘<_ c. P544,000
: a p. P707,200
B. F

ing from the transactions that woulq

result
4. The total expenses ne. statement for the year ended

n Baker's inco

appear 9
December 31,2018 should ?® 5 453 400
A. P1,255,760 D P183,400
B. P1,260,560 . 4
SOLUTION 6-18
- P 300,000
1. Down payment ,
Present value of 4 annual payments — 874,000
Total cost of franchise 1,174,000
Less: Amortization for 2018 (P1,174,000/10) __ 117,400
Carrying value of franchise, Dec. 31, 2018 P1.056.600
Answer: C
2. Cost of securing patent on Jan. 2, 2018 P272,000
Less: Amortization for 2018 (P272,000/8) 34,000
Carrying value of patent, Dec. 31, 2018 P238,000
Answer: A
3. Cost of trademark P640,000
Less: Amortization, July 1, 2015 - Dec, 31, 2018
.(P640,000/20 x 3 6/12) 112,000
Carrying value of trademark, Dec. 31, 2018 528.000
Answer: B .
4. Interest expense (P874,000 x 14%) P 122,360
Amortization of franchise (P1,174,000/10) 117,400
Amortization of patent (P272,000/8) 34,000

—_—_ Coe ——

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 539

Amortization of trademark (P640,000/20) 32,000
Franchise fee (P19,000,000 x 5%) 950,000
Total expenses P1.255.760

Answer: A

PROBLEM.6-19

Purchase of a Business
In line with CANDLER COMPANY’s expansion program, it has
become interested in acquiring a plant in Mindanao to handle many
of its production functions in that area. One prospective seller is
Sayo Na Co. whose owners have decided to sell their business if a
proper settlement can be obtained. Sayo Na Co.'s statement of
financial position appears as follows:

Current assets P 4,500,000 Current liabilities P 2,400,000

Investments 1,500,000 Noncurrent liabilities 3,000,090
Property, plant, and Ordinary shares 1,500,000
equipment (net) 12,000,000 Share premium 5,100,000
Retained earnings 6,000,000

Total assets P18,000.000 Total equities

Candler has hired Kilatis Appraisal Company to determine the

proper price to pay for Sayo Na Co. The appraisal company finds
that the investments have a fair value of P4,500,000 and the
inventory is understated by P2,400,000. All other assets and
equities are properly stated.

An examination of the company’s income for the last 4 years

indicates that the net income has steadily increased. In 2018, the
company had a net operating income of P3,000,000, which is
expected to increase 20% each year over the next 4 years. Candler
believes that a normal return in this type of business is 18% on net
arcunurenienera: AUDITING PROBL Ri4g

540
sset investment in the Mindanao plant is expecteg to
for the next 4 years- /
ir value of Sa
raisal Company, the fair va YO Na Co,
s App rent wayS: Calculate an estimate sf

ny diffe i
assuming that any goodwill will be

assets. The a
stay the same

According to Kilati
can be estimated in ma
the value of Sayo Na Co.
-computed as:
4. The capitalization of the average excess earnings of Sayo Na Co,
t 18%.
A 44,940,000 C. P18,286,416
B, P36,000,000 D. P26,840,000

2. The purchase of average excess earnings over the next four

years.
A. P24,364,800 C, P30,960,000
B. P19,591,200 D. P22,831,200

The capitalization of average excess earnings of Sayo Na Co, at

3.
24%.
A. P31,500,000 C. P18,381,888
B, P24,630,000 D. P98,520,000

4. The present value of the average excess earnings over the next
four years discounted at 15%. (The present value of an ordinary
annuity of 1 at 15% for 4 periods is 2.85498.)

A. P31,792,979 C. P22,542,844
B. P55,932,484 _ D. P27,250,135

5. If Candler were to pay P23,100,000 to purchase the assets and

assume the liabilities of Sayo Na Co, how much would be
charged to goodwill?

A. P8,840,000 C.. PO
B. P6,364,800 | D. P5,100,000

CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS 541

SOLUTION 6-19
Current assets (P4,500,000 + P2,400,000) P 6,900,000
Investments 4,500,000
Property, plant, and equipment (net) 12,000,000
Current liabilities (2,400,000)
Noncurrent liabilities (3,000,000)
Net assets at fair value
Normal earnings (P18,000,000 x 18%) P3.240,000
Projected net income:
2019 P 3,600,000
2020 4,320,000
2021 5,184,000
2022 6,220,800
Average earings over the next 4 years
(P19,324,800/4) P4,831,200
Average excess earnings (P4,831,200 - P3,240,000) PL.591.200
1. Goodwill (P1,591,200/18%) P 8,840,000
Fair value of net assets 4
Total P26,840,000
Answer: D
2. Goodwill (P1,591,200 x 4) P 6,364,800
Fair value of net assets “18,000,000
Total 224,364,800
"Answer: A
3. Goodwill (P1,591,200/24%) P 6,630,000
Fair value of net assets ° rey
Answer: B
cpa OMINATIN REVIEWEE AUDITING PROBLEMg 543
542 CHAPTER © AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS
P 4,542
4, Goodwill (P1,591,200 . —18,000,009 3. Goodwill is equal to the capitalization of
excess earnings at 15%.
Fair value of net 4 P22.542.844 A. P7,600,000 C. P4,666,667
Tot B. P8,466,667 D. P6,400,000
Answer: ©
/ P23,100,000
_ Purchase price , ;
Parc vaue of nt asses 18,000 SOLUTION 6-20
Goodwill P.5.100,009
Answer: D Total tert assets Sime
Less: Llabllities
Net assets P3,800,000
RAPBLER 6-20 Average rate of return on net assets x 15%
Goodwill Average earnings p.570,000
' ‘ Forecasted earnings P700,000
You have been instructed by CANNON COMPANY, a high-flying Average earnings _570,000
Excess earnings P130,000

conglomerate, to conduct a purchase audit of XYZ. Co.'s books to

determine a possible purchase price for XYZ Co.'s net assets: You

find the following information:

Total identifiable assets of XYZ Co. at fair market value P5,000,000

Liabilities 1,200,000"
Average rate of return on net assets for XYZ Co.'s industry . 15%
Forecasted earnings per year based on past earnings figures 700,000

Determine the purchase price on the basis of the following

assumptions:

1. Goodwill is equal to 3 years’ excess earnings.

A. P5,510,000 C. P3,930,000
B. P5,900,000 D. P4,190,000

2. ri is equal to the present value of excess earnings

iscounted at 15% for 3 years. (The present value factor of an
ordinary annuity of 1 at 15% for 3 periods is 2.28323 )
A. P5,398,261 C. P4690, 460 ,
B. P4,096,820 D. P5,101,441

1, Goodwill — 3 years’ excess earnings (P130,000 x 3)

Net assets
Purchase price
Answer: D

2, Goodwill (P130,000 x 2.28323)

Net assets
Purchase price

Answer: B
3. Goodwill-(P130,000 + 15%)
Net assets
Purchase price

Answer: C

P 390,000
3,800,000

P 296,820
_ 3,800,000
P4,096,820

P 866,667
AUDITING P.
a ern URMRATIN REVIEWER ROBLEMg

Goodwil

urchasing A & B Enterprises, which

Fair Market Value

p4,00,000 — P 4,400,000

WN

is considering P

KIN, INC. urc

a g assets and liabilities.

has the followin

ivable
a 4800,000 5,000,000
Prepaid Insurance 200,000 200,000
Buildings and equipment (net) 1,400,000 4,000,000
Accounts payable ) (3.200.900)
P10.400,000

Net assets

If the purchase price is P12,600,000, the amount of goodwill to be

charged in recording the acquisition is

A. P4,600,000 C. P2,200,000

B. P2,400,000 D. PO

SOLUTION 6-21

Purchase price P12,600,000

Fair market value of net assets ‘ 0,000

Goodwill po 700000
Answer: C

PROBLEM 6-22

Accounting for Computer Software Cost

DAURIAN

home cccmputeg a ees software for small businesses and

programmers are an he Most of the company’s computer

produce software th volved in developmental work designed '

at will perform fairly specific tasks in a usel”
545

CHAPTER G6 AUDIT OF PREPAYMENTS AND INTANGIBLE ASSETS

friendly manner. Extensive testing of the working model is

performed before it is released to production for preparation 0

masters and further testing. This careful preparation has resulted to

the production of several computer software packages that have

been very successful in the marketplace.

Daurian incurred the following costs during 2016:

Salaries and wages of programmers doing research

ment of

Expenses related to projects prior to establish

technological feasibility 235,200

Expenses related to projects after technological feasibility

has been established but before software is available
for commercial production

Amortization of capitalized software development costs

from current and prior years

Costs to produce and prepare software for sale

P705,000

148,500

80,250
168,900

Additional data for 2018:

P1,545,000

Sales of products for the year

Beginning inventory 426,000

Portion of goods available for sale sold during year 60%
Income tax rate is 30%

What is Daurian’s net income for 2018?

A. P139,797 C. P215,072
B. P195,681 D. P243,746

SOLUTION 6-22 .

Sales P1,545,000

Cost of goods sold:

Beginning inventory P426,000
Software production costs (including
p
CEUTA: AUDITING PROB»,

546
rtizati i ftware
amortization of capitalized so
costs) (P168,900 + P80,250) 249,130
Goods available for sale 675,150

Ending inventory (40% x P675,150) 270,060 405,

Gross income —— 1,139,919

Expenses:
Salaries and wages of programmers P705,000
Research-related expenses 235,200 940,200
Income before income tax 199,71
Income tax (30%) 59,913
Net income P139,797

Answer: A