In this video, we walk through 5 FAR practice questions teaching about calculating the carrying amount of finite-lived intangible assets. These questions are from FAR content area 2 on the AICPA CPA exam blueprints: Select Balance Sheet Accounts.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Calculating the Carrying Amount of Finite-Lived Intangible Assets
Understanding how to calculate the carrying amount of finite-lived intangible assets is crucial for ensuring accurate financial reporting. This process involves three key stages: determining the initial measurement, calculating amortization, and recognizing impairment when necessary. Below, we break down each of these components, providing guidance on what to include and exclude, how to apply amortization rules, and how to handle impairment losses.
1. Initial Measurement of Finite-Lived Intangible Assets
The initial measurement of a finite-lived intangible asset involves determining the capitalized cost at the time of acquisition. This cost includes certain directly attributable expenses but excludes others.
- Included in the Capitalized Cost:
- Purchase Price: Any cash or consideration paid directly for the acquisition.
- Fair Value of Exchanged Property: If property or assets are exchanged for the intangible asset, their fair value (not their book value) is included in the initial measurement.
- Legal Fees: Costs incurred to apply for, secure, or defend the rights to an intangible asset are capitalized if they are directly tied to the acquisition or protection of the asset.
- Successful Defense Costs: Legal fees for successfully defending the rights of a patent or trademark are added to the carrying amount of the asset.
- Excluded from the Capitalized Cost:
- R&D Costs: Research and development expenses are expensed as incurred under U.S. GAAP, not capitalized.
- Franchise and Operational Revenue: Income generated from the use of the intangible asset is not included in the initial cost.
- Costs to Develop the Asset: Costs associated with internally developing an intangible asset are typically expensed.
- Unsuccessful Defense Costs: If a company fails to defend the rights to an intangible asset, any legal costs associated with the unsuccessful defense are expensed immediately, and the asset may be subject to impairment.
2. Amortization of Finite-Lived Intangible Assets
Once the initial cost is determined, finite-lived intangible assets must be amortized over their useful life. Amortization reflects the gradual consumption of the asset’s value over time.
- Useful Life Determination: Amortization should be based on the lesser of the legal life of the intangible asset (the period the legal rights are valid) or its economic life (the time period during which the asset is expected to generate cash flows). For example, a patent may have a legal life of 20 years, but if the company expects to benefit from it for only 12 years, the patent would be amortized over 12 years.
- Amortization Calculation: Amortization is calculated using the straight-line method unless another method better reflects the pattern of the asset’s use. The formula for straight-line amortization is:
- Amortization Expense = (Capitalized Cost – Residual Value) / Useful Life
- Typically, intangible assets do not have a residual value, meaning the entire capitalized cost is spread over the useful life. For example, if an asset has a capitalized cost of $100,000 and a useful life of 10 years, the annual amortization expense would be $10,000.
- Impact on the Carrying Amount: Each year, the amortization expense is deducted from the carrying amount of the asset. This process continues until the carrying amount is reduced to the residual value (if any).
3. Impairment of Finite-Lived Intangible Assets
An impairment occurs when an intangible asset’s carrying amount exceeds its recoverable amount due to events or changes in circumstances that negatively impact its value. For finite-lived intangible assets, impairment testing is typically triggered when there are indications that the asset may no longer generate the expected economic benefits.
- Impairment Triggering Events: Examples include technological advancements that render a patent obsolete, new market regulations, or a decline in the demand for products associated with the intangible asset.
- Calculating the Impairment Loss:
- Step 1: Determine the carrying amount of the asset, which is the capitalized cost minus accumulated amortization.
- Step 2: Identify the fair value of the asset, which is the price it would sell for in the open market or the present value of expected future cash flows.
- Step 3: Calculate the impairment loss as the difference between the carrying amount and the fair value:Impairment Loss = Carrying Amount – Fair Value
- Permanent Impairment: In cases where an intangible asset loses all economic value due to events such as losing legal rights or a complete market shift, the impairment loss would write down the asset’s value to zero.
- For example, if a patent with a carrying amount of $50,000 becomes obsolete due to new technology, and its fair value is now $0, the company would record a $50,000 impairment loss.
Key Takeaways
- Initial measurement of finite-lived intangible assets includes the purchase price, fair value of exchanged property, and legal fees but excludes R&D costs and income generated from the asset.
- Amortization is based on the lesser of the asset’s legal or economic life, and it reduces the carrying amount each year.
- Impairment testing is required when events indicate a decline in value, and any loss reduces the asset’s carrying amount to its fair value, with permanently impaired assets written down to zero.