No. 125 Brgy.

San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : icarecpareview@gmail.com

AP04-05 jsabellar/aljabinal/aeibay

AUDIT OF INTANGIBLE ASSETS

Audit Objectives:
Assertions Account Balances Audit Objectives
Existence All Intangible assets presented in the statement of financial position exist.
All intangible assets are owned and/or controlled are recorded and included in
Completeness
the statement of financial position.
The intangible assets are stated in the statement of financial position at the
Valuation and Allocation
appropriate amounts.
All intangible assets presented in the statement of financial position are
Rights and Obligations owned and/or controlled by the Company and any liens thereto are disclosed
in the financial statements.
All intangible assets are properly classified, described, and disclosed in the
Presentation and
financial statements, including the notes to financial statements, in
Disclosure
accordance with the applicable financial reporting framework.

Audit Procedures for Intangible Assets:

Assertions and Audit
Audit Evidence and Procedures
Objectives
Existence, Completeness, A. General Procedures for the Audit of Intangibles:
• Do recorded intangible assets o Obtain Intangible Assets Schedule and match totals with the
exist? trial balance. Ensure that amounts matches.
o Obtain Accounting Policy for Intangibles.
• Are purchased intangible o Obtain Minutes of Board Meetings for Intangibles additions
assets properly recorded at and/or disposals and other matters that may affect
acquisition cost less Intangibles.
accumulated amortization? o Determine movements in the Intangibles (e.g. Additions,
Disposals, etc.)
• Have research and
development expenditures B. Procedures for Intangibles Existence and Completeness:
been properly charged in o Examine documentation supporting intangibles:
accordance with applicable • Patents, copyrights, and trademarks; and
financial reporting • Franchise and merger agreements
framework? o Vouch additions and disposals:
• Include research and development expense; and
• Do reported intangible assets • Be alert to the possibility of purchased intangibles
possess further economic being debited to R&D expense and/or vice versa.
benefits? o Examine minutes for proper authorization of acquisitions
and disposals.
C. Procedures for Intangibles Valuation and Ownership
o Vouch additions and disposals on a test basis:
• Agreements
• Canceled checks
• Be particularly alert to the possibility of capitalized
R&D or related-party transactions; and
• Trace receipts from disposals to bank statements
 D. Procedures for Presentation and Disclosure
o Hearsay evidence:
• Inquire management and legal counsel as to
possible contingencies relating to intangible assets
(e.g., patent infringement)
• Inquire of management as to possible “asset
impairment” if conditions so suggest.
o Analytical evidence:
• Evaluate future economic benefit by relating assets
to revenue produced by them.
• Determine need for asset impairment test:
 Examine management’s documentation of
test;
 Examine appraisal reports and cash flows
forecast; and
 Determine the carrying amount of impaired
assets do not exceed fair values.
• Compare research and development expense with
that of prior year and investigate major changes
(may be the result of errors in classifying
expenditures)

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 A. SUBSTANTIVE TESTING:

1. The 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?
b. Inquiry
c. Observation
d. Analytical review
e. Inspection of documents

2. Which of the following characteristics do intangible assets possess?

a. Physical existence.
b. Claim to a specific amount of cash in the future.
c. Long-lived.
d. Held for resale.
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 to determine that only such 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 client has just acquired another company by purchasing all its assets. As a result of the
purchase, goodwill has been recorded on the client’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% if 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 recomputed 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 and occurrence
d. Rights and obligations

7. Operating losses incurred during the start-up years of a new business should be
a. Accounted for and reported like the operating losses of any other business.

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 b. Written off directly against retained earnings.
c. Capitalized as a deferred charge and amortized over five years.
d. Capitalized as an intangible asset and amortized over a period not to exceed 20 years.

8. Which of the following intangible assets should be shown as a separate item on the balance
sheet?
a. Goodwill
b. Franchise
c. Patent
d. Trademark

9. Which of the following would not be considered an R&D activity?

a. Adaptation of an existing capability to a particular requirement or customer’s need.
b. Application of research findings or other knowledge to a plan for a new product or
process.
c. Laboratory research aimed at discovery of new knowledge.
d. Conceptual formulation and design of possible product or process alternatives.

10. Information regarding the legal life and useful life of the company’s patent is related to what
financial statement assertion?
a. Disclosure and Valuation
b. Completeness and Validity
c. Existence and Presentation
d. Accuracy and Existence

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PROBLEM NO. 1
LUNA COMPANY began operations on January 2, 2011. Shown below is the balances of its
INTANGIBLE ASSETS as of December 31, 2019.

Patents P 1,650,000
Franchise agreement 285,000
Organization costs 306,000
Goodwill 1,035,000

Additional Information:

1. Patents, acquired January 2, 2012, are being amortized over an expected useful life of 14
years. Repairs made to equipment covered by the patents costing P225,000 were debited to the
account in January 2016. It is further determined on December 31, 2018, that one of the patents
has a remaining life of only 2 years. This patent was originally assigned a cost of P630,000.

2. A franchise agreement was signed on January 1, 2019. A P150,000 fee was paid, covering a 5-
year period, at the end of which the company may renew the agreement by paying P150,000. A
decision on renewal has not been made as of December 31, 2019. The agreement calls for an
annual payment of 5% of revenue. An entry debiting the account for P135,000 was made at the
time of the cash payment for 2019.

3. Organization costs include the unamortized portion of amounts paid to promote for services
rendered at the inception of the corporation. These fees have been amortized since inception over
an estimated 40-year life.

4. Goodwill account includes the following: P135,000 – legal expenses relative to incorporation.
These were assigned to the account in January 2011; P600,000 excess of cost over assigned fair
value of identifiable net assets of an enterprise acquired in early 2017; P300,000 paid to an
advertising consulting firm for a major advertising effort.

Answer the following:

1. What is the carrying value of the Patents on December 31, 2019?
2. What is the carrying value of the Franchise Agreement on December 31, 2019?
3. What is the carrying value of the Organization Costs on December 31, 2019?
4. What is the carrying value of Goodwill on December 31, 2019?
5. What is the total Patent amortization for 2019?

PROBLEM NO. 2
Information concerning QT’s intangible assets is as follows:
a. On January 1, 2020, QT signed an agreement to operate as franchisee of Roulette Copy
Service, Inc., for an initial franchise fee of P85,000. Of this amount P25,000 was paid when
the agreement was signed, and the balance is payable in four annual payments of P15,000
each beginning January 1, 2021. The agreement provides that the down payment is not
refundable and no future services are required by the franchisor. The present value at
January 2, 2020 of the four annual payments discounted at 14% implicit rate for a loan of
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 this type is P43,700. The agreement also provides that 5% of the revenue from the franchise
must be paid to the franchisor annually. QT’s revenue from the franchise for 2020 was
P900,000. QT estimates the useful life of the franchise to be 10 years

b. QT incurred P78,000 experimental and developmental costs in its laboratory to develop a

patent, which was granted on January 2, 2019. Legal fees and other costs associated with
the registration of the patent totaled P16,500. QT estimates that the useful life of the patent
will be 8 years.

c. A trademark was purchased from West Company for P40,000 on July 1, 2017. Expenditures
for successful litigation in defense of the trademark totaling P10,000 were paid in July 1,
2020. QT estimates that the useful life of the trademark will be 20 years from the date of
acquisition.

d. QT purchases Supplier Company for P800,000 cash on January 1, 2020. The book value of
Supplier Company’s net assets, as reflected on its December 31, 2019 balance sheet is
P620,000. An analysis by QT on December 31, 2019 indicates that the fair value of
Supplier’s tangible assets exceeded the book value by P60,000, and the fair value of
identifiable intangible assets exceeded book value by P45,000.

Based on the information provided, answer the following:

1.The audited balance as of December 31, 2020 of the Franchise from Roulette Copy Services net
of amortization is:
a. P61,830 c. P25,000
b. P68,700 d. P68,130

2. The audited balance as of December 31, 2020 of the Trademark, net of amortization is
a. P42,706 c. P33,000
b. P50,000 d. P40,000

3. The amount of goodwill as of December 31, 2020 is:

a. P -0- c. P120,000
b. P180,000 d. P75,000

4. The total intangible assets as of December 31, 2020 is:

a. P109,180 c. P101,980
b. P182,130 d. P184,180

5. The expenses resulting from intangible transactions for 2020 amounted to

a. P72,038 c. P62,038
b. P62,332 d. P70,038

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PROBLEM NO. 3
POGI AKO, Inc. was organized in 2019. Its accounting records include only one account for all
intangible assets. The following is a summary of the entries that have been recorded and posted
during the years 2019 and 2020:

Date Intangible Assets Amount

01/02/19 Acquired a franchise without definite useful life P 252,000
10/01/19 Advance payment on lease expiring on October 1, 2021 168,000
12/31/19 Net loss for 2019 included incorporation fee, P6,000, and related 96,000
legal fees of organizing the business, P30,000 (all incurred in 2019)
01/02/20 Acquired patent with as useful life of 10 years 444,000
03/31/20 Cost of developing an Intangible Asset A 450,000
04/01/20 Goodwill purchased in a business combination 1,670,400
07/01/20 Legal fees for successful defense of patent on 01/02/20 75,900
10/01/20 R&D cost on a new project – Intangible B 160,000

Audit notes:
• It was ascertained by the end of 2019 that the expected annual net cash flows from
continued use of the franchise was P50,000. By the end of 2020, due to decline in the
demand for the product related to the franchise the annual net cash flows was expected to
decrease by 40%.

• By the end of 2020, it was apparent that the competitor has launched a more superior
system that was protected by the patent, thus, it was estimated that the expected life of the
patent shall be cut in half from acquisition date. Furthermore, it was also ascertained that
expected net cash flows from the patent shall be at P100,000.

• 75% of the development cost for the Intangible Asset A was incurred after the completion
of technical feasibility. The Intangible Asset A is expected to be useful for 3 years and was
placed in operation on June 30, 2020.

• Technical feasibility on the Intangible Asset B is yet to be established as of the balance

sheet date December 31, 2020.

• The appropriate discount rate remained at 12% for both years.

Based on the information above:

1. How much total expense should be recognized in the 2020 income statement in relation to
the patent?
a. 44,400 c. P159,422
b. P120,300 d. P216,165

2. What is the carrying value of the franchise as of December 31, 2020?

a. P226,800 c. P250,000
b. P252,000 d. P201,600
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 3. How much total expense should be recognized in the 2020 Income Statement in relation to
the internally generated intangibles?
a. P216,250 c. P356,875
b. P328,750 d. P610,000

4. 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 assert of:
a. Valuation c. Completeness
b. Existence d. Rights and obligation

5. Examining documents of the purchase of intangible assets is consistent with the auditor’s
objective of validating the management’s assertion of
a. Valuation c. Completeness
b. Existence d. Rights and obligation
PROBLEM 4:
The following independent situations relate to the audit of intangible assets. Answer the
question/s at the end of each situation.

BERNARD Technology, Inc. reports the following patents on its December 31, 2018, statement
of financial position.
Initial Cost Date of Acquisition Useful life
Patent: A P 408,000 March 1, 2015 17 years
B 150,000 July 1, 2016 10 years
C 144,000 September 1, 2017 4 years

The following events occurred during the year ended December 31, 2019.
1. Research and development costs of P245,700 were incurred during the year. These costs were
incurred prior to projects achieving economic viability.
2. Patent D was purchased on July 1 for P285,000. It has a remaining life of 9 ½ years.
3. A possible impairment of Patent B’s value may have occurred at December 31, 2019.
Estimated future cash flows amounted to P20,000 for the next three years. Appropriate
discount rate is 8%

Answer the following:

1. Total carrying value of BERNARD’s patents on December 31, 2018.
2. Amount of impairment loss to be reported by BERNARD as of December 31, 2019.
3. Total carrying value of BERNARD’s patents on December 31, 2019.

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