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Lesson 2: Audit of Intangible Assets

Intangible asset is an identifiable non-monetary asset without physical substance. They are different from other kinds
of assets such as equipment, machinery, and building, which we can see with our eyes

Similar to other assets on the balance sheet, we perform the audit of the intangible asset by testing several audit
assertions such as existence, valuation, right and obligation, and completeness.

Audit assertions for intangible asset

The audit assertions for intangible assets are included in the table below:
Assertions Description Audit Procedures

1. Obtain analysis of ledger accounts for

The intangible assets reported on the balance intangibles
Existence
sheet really exist at the reporting date. 2. Examine documentation supporting
intangibles

3. Vouch additions to or acquisitions

All intangible asset transactions that should have during the year
Completeness
been recorded have been recorded. 4. Evaluate dispositions and write-offs
during the year

The company really owns all intangible assets

5. In addition to no. 2, perform analytical
Right and obligation reported on the balance sheet as of the reporting
procedures
date.

6. In addition to nos. 3 & 4, evaluate

The balance of intangible assets truly reflects
Valuation amortization policy and verify the
their actual economic value.
computation of amortization

Intangible assets have been properly presented 7. Evaluate financial statement

Presentation and
on the balance sheet and adequate disclosure has presentation and disclosure for
disclosure
been made in the note to financial statements. intangibles

Recognition and measurement

Per PAS 38, recognition of intangible assets must meet the following conditions:

a. Identifiability: the definition of an intangible asset requires an intangible asset to be identifiable to distinguish it
from goodwill. An asset is identifiable if it either (a) is separable or (b) arises from contractual or other legal rights.
b. Control: Intangible assets must be under the control of the entity. An entity controls an asset if the entity has the
power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others
to those benefits
c. Future economic benefit: The entity expects to generate future economic benefits from assets. The future
economic benefits flowing from an intangible asset may include revenue from the sale of products or services, cost
savings, or other benefits resulting from the use of the asset by the entity.
d. The cost of the asset can be measured reliably.
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Intangible asset shall be measured initially at cost.

Examples of Intangible Assets

1. Patent: is the intellectual property that gives the owner an exclusive right to on his or her innovation. It prevents
the copycat from taking benefit from the owner by copying the original idea.
2. Trademark: is the written mark which company uses to identify its goods or service. It is a unique design that
differentiates from the competitor.
3. The customer list: is the list of previous company customers which is the potential to make more sales in the
future.
4. License: is the official permit from the government, which allows the entity to run a business, provide a particular
service, or own something.
5. Software: is the computer application which allows the human to perform many tasks on the computer.

Internally generated goodwill

Internally generated goodwill shall not be recognized as an asset. Internally generated goodwill is not recognized as
an asset because it is not an identifiable resource (i.e., it is not separable, nor does it arise from contractual or other
legal rights).

Internally generated intangible assets

To assess whether an internally generated intangible asset meets the criteria for recognition, an entity classifies the
generation of the asset into:
(a) a research phase; and
(b) a development phase.

Research phase Development phase

No intangible asset arising from research (or from the An intangible asset arising from development (or from
research phase of an internal project) shall be the development phase of an internal project) shall be
recognized. Expenditure on research (or on the recognized if, and only if, an entity
research phase of an internal project) shall be can demonstrate all of the following:
recognized as an expense when it is incurred. (a) the technical feasibility of completing the intangible
asset so that it will be available for use or sale.
Examples of research activities are: (b) its intention to complete the intangible asset and use
(a) activities aimed at obtaining new knowledge; or sell it.
(b) the search for, evaluation and final selection of, (c) its ability to use or sell the intangible asset.
applications of research findings or other knowledge; (d) how the intangible asset will generate probable
(c) the search for alternatives for materials, devices, future economic benefits. Among other things, the entity
products, processes, systems or services; and can demonstrate the existence of a market for the output
(d) the formulation, design, evaluation and final of the intangible asset or the intangible asset itself or, if
selection of possible alternatives for new or improved it is to be used internally, the usefulness of the
materials, devices, products, processes, systems or intangible asset.
services. (e) the availability of adequate technical, financial and
other resources to complete the development and to use
or sell the intangible asset.
(f) its ability to measure reliably the expenditure
attributable to the intangible asset during its
development.

Examples of development activities are:

(a) the design, construction and testing of pre-
production or pre-use prototypes and models;
(b) the design of tools, jigs, moulds and dies involving
new technology;
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(c) the design, construction and operation of a pilot plant

that is not of a scale economically feasible for
commercial production; and
(d) the design, construction and testing of a chosen
alternative for new or improved materials, devices,
products, processes, systems or services.

If an entity cannot distinguish the research phase from the development phase of an internal project to create an
intangible asset, the entity treats the expenditure on that project as if it were incurred in the research phase only.

Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not
be recognized as intangible assets. Expenditure on internally generated brands, mastheads, publishing titles,
customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a
whole. Therefore, such items are not recognized as intangible assets.

Measurement after recognition

An entity shall choose either the cost or revaluation models as its accounting policy. If an intangible asset is
accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same
model, unless there is no active market for those assets.

Cost model
After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortization and any
accumulated impairment losses.

Revaluation model
After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the
revaluation less any subsequent accumulated amortization and any subsequent accumulated impairment losses. Under
this model, the increasing value will record as comprehensive income and accumulated in “revaluation surplus” in
equity. The decreasing amount will reverse back from this surplus.

For the purpose of revaluations under this Standard, fair value shall be measured by reference to an active market.
Revaluations shall be made with such regularity that at the end of the reporting period the carrying amount of the asset
does not differ materially from its fair value.

Amortization
Intangible assets with finite useful lives
The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its
useful life. The amortization method used shall reflect the pattern in which the asset’s future economic benefits are
expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method shall
be used.

Intangible assets with indefinite useful lives

An intangible asset with an indefinite useful life shall not be amortized. In accordance with PAS 36, an entity is
required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable
amount with its carrying amount
(a) annually, and
(b) whenever there is an indication that the intangible asset may be impaired.
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References:
IAS 38 – 2021 Issued IFRS Standards (Part A) [https://www.ifrs.org/content/dam/ifrs/publications/pdf-
standards/english/2021/issued/part-a/ias-38-intangible-assets.pdf]
Accountinguide. Audit Intangible Asset [https://accountinguide.com/audit-intangible-asset/]
Accountinguide. Accounting for Intangible Assets [https://accountinguide.com/intangible-asset/]

PROBLEMS

Problem 1
You gathered the following information related to the Patents account of the CCC Corporation in connection with
your audit of the company's financial statements for the year 2022.

In 2021, CCC developed a new machine that reduces the time required to insert fortunes into its fortune cookies.
Because the process is considered very valuable to the fortune cookie industry, CCC patented the machine. The
following expenses were incurred in developing and patenting the machine:

Research and development laboratory expenses 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
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) 1,200,000
Expense of drawing required 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 2022, CCC paid P150,000 in legal fees to successfully defend the patent against an infringement suit by
LCBA Corporation.

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

Questions:
Based on the given information and the result of your audit, determine the following:
1. Cost of patent
a. P580,000 c. P798,000
b. P648,000 d. P1,128,000

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

3. Total amount that should be charged to expense when incurred in connection with the development of the patented
machine
a. P0 c. P1,480,000
b. P1,000,000 d. P1,608,000
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4. Carrying amount of patent as of December 31, 2022

a. P522,000 c. P837,900
b. P583,200 d. P1,015,200

Problem 2
In connection with your audit of the CCC Corporation's financial statements for the year 2022 you noted the following
items relative to the company's Intangible assets.

A patent was purchased from LCBA Company for P4,000,000 on January 2, 2021. CCC estimated that the remaining
useful life of the patent to be 10 years. The patent was carried in LCBA's accounting records at a carrying value of
P4,000,000 when LCBA sold it to CCC.

During 2022, a franchise was purchased from SJC Company for P960,000. In addition, 5% of the revenue from the
franchise must be paid to SJC. Revenue from the franchise for 2022 was P5,000,000. CCC estimates the useful life of
the franchise to be 10 years and takes a full year's amortization in the year of purchase.
CCC incurred research and development costs of P866,000 in 2022. CCC estimates that these costs will be recouped
by December 31, 2025.

On January 1, 2022, CCC, because of the recent events in the industry, estimates that the remaining life of the patent
purchased on January 2, 2021, is only 5 years from January 1, 2022.

Questions:
Based on the given information and the result of your audit; determine the following:
1. Amortization of patent for 2022
a. P400,000 c. P800,000
b. P720,000 d. P900,000

2. Carrying amount of patent as of December 31, 2022

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

3. Carrying amount of intangible assets as of December 31, 2022

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

4. Total expenses to be recognized in 2022

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

Problem 3
In connection with your audit of the CCC Corporation, you noted the following transactions during 2022:

Jan. 2 Paid legal fees of P450,000 and other costs of P249,000 to complete organization of the corporation.
15 Hired a clown to stand in front 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
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It is estimated that in 6 years other companies will have developed improved processes, making the
CCC 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 CCC'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
2022.

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

Questions:
Based on the given information and the result of your audit, determine the following:
1.Cost of patent
a. P0 c. P1,287,000
b. P 190,500 d. P1,477,500

2. Cost of licenses
a. P0 c. P450,000
b. P300,000 d. P600,000

3. Cost of trademark
a. P0 c. P450,000
b. P300,000 d. P600,000

4. Carrying amount of Intangible Assets as of December 31, 2022

a. P0 c. P2,026,250
b. P1,981,250 d. P2,031,250

5. Total amount resulting from the foregoing transactions that should be expensed when incurred 0
a. P0 c. P2,971,500
b. P1,494,000 d. P5,424,000

Problem 4
4.1 CCC Company incurred the following costs during 2022 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 projects 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
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1. Compute the amount that will be classified and recognized as research and development expense.
a. P1,465,000 c. P1,965,000
b. P1,685,000 d. P2,135,000

4.2 CCC, Inc. incurred the following costs during the year ended December 31, 2022:
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 LCBA Corporation 525,000
Testing for evaluation of new products 337,500

2. Compute the amount that will be classified and recognized as research and development expense.
a. P300,000 c. P855,000
b. P637,500 d. P1,380,000

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