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WEEK 4 ASSIGNMENT-CASE 2
Case 2-Patent AccountingAbstract
Week 4 Assignment-Case 2
You have been hired as a consultant for XYZ Research Co. XYZ Research Co. Incorporated in 2010. XYZ‘s business centers on developing new technology for interplanetary exploration. The company has many patents and has historically expensed all of the costs associated with obtaining their patents. The owners of XYZ Labs are unsure whether or not if any or all of its patent costs can be capitalized. They also are unsure if any impairment testing should be done periodically on their patents. You have been asked by the owners to look into these issues and provide the appropriate accounting treatment for patents.
Gather data from multiple sources and present that data in one to two pages (12-point font, double-spaced).Be sure to document your sources.
Case 2- Patent Accounting
Intangible Assets-The two predominate characteristic of intangible assets are their absence of physicality and they are not a financial instruments. They are normally categorized as long-term assets. In most cases, intangible assets provide services over a period of years (Kieso, 2012).
Utility Patents-Utility patents are property rights granted by the government to inventors. The invention or discovery any new and useful process, software or machine, or any new functional improvement to an existing invention is a utility patent (Chizoba, 2013).The patent will provide the inventor exclusive rights for 20 years against market competition from the filing date.
Self-Created Patents-This type of patent is created within an entity.
Purchased Patent-An entity buys a patent on its own or as part of a group of assets during acquisition of a company.
Valuation of a Patent-There is a number of reasons to determine the valuation of a patent. Some of the reason for valuation include transfer of ownership, tax issues, financial reporting, financing, and legal issues. Sometimes financial statements will expense or amortize the value of patents, and sometimes they don't. And, anyone looking at the patent amortization expenses reported on a company's tax return will not find a similar amount of expense on the financial statements of the company (Rutter, 2004).
Economic Analysis Method: Three approaches are used in this valuation method: cost, income, and market. The economic-analysis valuation method has three approaches: cost, income, and market. Cost Approach-The Cost Approach values the patents at its replacement cost or the right to protect the patent. Replacement costs are at present value and are used to determine the amount of money to replace a patented invention. To sell a patent the purchase price will have to be competitive to the amount it would cost an entity to purchase a similar patent. Cost-based approaches are only used in limited circumstances (e.g. when the replacement cost can be estimated with a reasonable degree of reliability and confidence). Cost is, however, a relevant benchmark where a patent has recently been acquired see Market-Approach (von Scheffer & Zieger, 2005). Income Approach-This method determines valuation by way of future cash flows. The Income Approach bases valuation on future benefits, the potential of a product to be patented, increased sales or reduction of company costs. Provided that information of an appropriate quality can be obtained this is a primary valuation methodology and the most widely used in practice, the limiting nature of the assumptions needs to be understood and where possible scenario analysis should be performed(von Scheffer & Zieger, 2005).
Market Approach-This methodology involves determining what a willing buyer would pay for similar property. The Market Approach bases valuation on previous purchases or like patents in the market. To use this approach for valuation there must be an active market for these patent or previous transactions with equivalent property. Look for similarities when comparing patents-prospective growth, market share, and industry attributes. If information on recent transactions involving patents exists this is an extremely important indicator of value. However, in practice, sufficient information is rarely disclosed and this methodology is used as a cross check on other more theoretical methodologies (von Scheffer & Zieger, 2005).
Research & Development Expenditures: Costs incurred in a planned search for new knowledge and in translating such knowledge into new products or processes. Patents are not easily expensed because they are intangible assets. Calculate the value of a patent on the balance sheet using its development costs or purchase price.
Amortization: The allocation of costs for intangible assets over the projected useful life of the asset. The most common expense method used is the straight-line method of amortization. Under US GAAP, the cost of intangible assets are either amortized over their respective useful/legal lives, or are tested for impairment on an annual basis. Amortization is the systematic write-off of the cost of an intangible asset to an expense, which effectively allocates a portion of the intangible asset's cost to each accounting period in the economic or legal life of the asset (an amortization expense). Only recognized intangible assets with finite useful lives are amortized. This differs from tangible assets which are depreciated (resulting in a depreciation expense) over their useful lifeUnder US GAAP, the cost of intangible assets are either amortized over their respective useful/legal lives, or are tested for impairment on an annual basis. Amortization is the systematic write-off of the cost of an intangible asset to an expense, which effectively allocates a portion of the intangible asset's cost to each accounting period in the economic or legal life of the asset (an amortization expense). Only recognized intangible assets with finite useful lives are amortized. This differs from tangible assets which are depreciated (resulting in a depreciation expense) over their useful lifeUnder US GAAP intangible asset costs are amortized over their useful or legal life or annually tested for impairment only recognized intangible assets with finite useful lives are amortized. This differs from tangible assets, which are depreciated (resulting in a depreciation expense), over their useful life (Boundless, 2013).
Straight-Line Method: Divide the total cost of the asset by the useful life of the asset for the annual amortization expenses.
Capitalization: An expense added to the cost basis of a fixed asset on a company's balance sheet. These costs are not expensed in the period they are incurred, but are amortized over a period.
Useful Life: A set period before the patent expires and competitors can enter the marketplace. A patent asset should not be amortized for longer than the life span of the protection afforded by the patent. Thus, the shorter of a patent's useful life and its legal life should be used for the amortization period (Bragg, 2014).
Economic: The economic life is the length of time you expect the patent to bring in revenue for the company.
Legal: The legal life of a patent is the time until it expires.
Impairment of Intangible Assets: The amount by which the carrying value of the asset exceeds its fair value. Impairment testing should do on an annual basis or when the possibility of an asset is carrying value in not recoverable. Examples:
- Significant decrease in the asset’s market price
- Significant adverse change in the asset’s manner of use
- Significant adverse change in legal factors or the business climate that could affect the asset’s value
- Excessive costs incurred to acquire or construct the asset
- Historical and projected operating or cash flow losses associated with the asset
- The asset is more than 50% likely to be sold or otherwise disposed of significantly before the end of its previously estimated useful life (Bragg, 2014).
Limited Life Intangibles: Intangible assets with a limited useful life.
Loss of Impairment: Asset impairment is a significant, unexpected reduction in a capital assets’ service utility. Once impairment has been established it must be recorded as impairment loss; intangible assets is credited and impairment loss is debited; previous impairment loss cannot be reversed. If full amortization of an asset has not taken place at the time of de-recognition then the unamortized balance is recorded as a loss.
Presentation of Intangible Assets and Related Items-FASB Requirements:
FASB Statement No. 142: requires a company to disclose certain information about its intangible assets, in either the financial statement or its footnotes. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No 17, Intangible Assets (FASB, 2001). FAS 142 was issued in tandem to FAS 141 governing the amortization expense, impairment testing write-offs, and intangible assets from business combinations. Intangible assets are separated into assets subject to amortization and assets not subject to amortization. In essence, an intangible asset with an indefinite useful life is not amortized while all others are amortized. Identifiable intangible assets that is finite and amortized over their useful lives. Identifiable intangible assets have indefinite life and are not be amortized. Identifiable intangible assets that have a finite life will continue to assess for impairment in accordance with the standard on the impairment of long-lived assets. An intangible asset with an indefinite life will be required to use a one-step impairment test, which requires an impairment to be recorded if the carrying amount of the identifiable intangible is in excess of its fair value (Brand, 2001)
FASB No. 2: Accounting for Research and Development Costs. This Statement establishes standards of financial accounting and reporting for research and development costs. This Statement requires that R&D costs be charged to expense when incurred. It also requires a company to disclose in its financial statements the amount of R&D that it charges to expense (FASB, 1974).
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FASB. (1974). Statement of FASB No. 2.FASB-Accounting for Research and Development
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