Principles of Financial Accounting: Plant Assets and Intangibles - Intangible Assets, Patents Copyrights Trademarks Franchises Goodwill

What It Is

Intangible assets are non-physical assets with a life beyond one year, such as patents, copyrights, trademarks, franchises, and goodwill. These assets are essential in financial accounting as they represent a company's long-term investments in its brand, technology, and intellectual property. For example, if a company purchases a patent for $50,000, it will be recorded as an intangible asset on the balance sheet.

Key Concepts & Formulas

• Amortization: The process of allocating the cost of an intangible asset over its useful life. Amortization Expense = Cost / Useful Life. For example, if a patent costs $50,000 and has a useful life of 10 years, the annual amortization expense would be $5,000.
• Patent: A government-granted exclusive right to make, use, and sell an invention. Patent Cost = Purchase Price + Acquisition Costs. For example, if a company purchases a patent for $50,000 and incurs $5,000 in acquisition costs, the total patent cost would be $55,000.
• Copyright: A legal right to reproduce, distribute, and display original literary, dramatic, musical, and artistic works. Copyright Cost = Purchase Price + Acquisition Costs. For example, if a company purchases a copyright for $20,000 and incurs $2,000 in acquisition costs, the total copyright cost would be $22,000.
• Trademark: A distinctive sign or symbol that identifies a company's products or services. Trademark Cost = Purchase Price + Acquisition Costs. For example, if a company purchases a trademark for $30,000 and incurs $3,000 in acquisition costs, the total trademark cost would be $33,000.
• Franchise: A license granted by a company to another company to operate its business. Franchise Cost = Purchase Price + Acquisition Costs. For example, if a company purchases a franchise for $40,000 and incurs $4,000 in acquisition costs, the total franchise cost would be $44,000.
• Goodwill: The excess of the purchase price of a business over the fair value of its identifiable assets. Goodwill = Purchase Price - Net Assets. For example, if a company purchases a business for $100,000 and the net assets are $80,000, the goodwill would be $20,000.
• Impairment: The reduction in value of an intangible asset due to various factors such as obsolescence or changes in market conditions. Impairment Loss = Carrying Value - Recoverable Amount. For example, if an intangible asset has a carrying value of $50,000 and a recoverable amount of $30,000, the impairment loss would be $20,000.

Journal Entry Examples

1. Purchase of Patent

Dr. Patent $50,000 Cr. Cash $50,000

Explanation: The patent is recorded as an intangible asset, and the cash is reduced by the purchase price.

1. Amortization of Patent

Dr. Amortization Expense $5,000 Cr. Patent $5,000

Explanation: The amortization expense is recorded as an expense, and the patent is reduced by the amortization amount.

Common Mistakes

1. Mistake: Confusing debits and credits for intangible assets. Correction: Intangible assets are recorded as assets, so they are debited when purchased and credited when sold or impaired. Remember the mnemonic "Assets Are Debitable" (AAD).
2. Mistake: Failing to amortize intangible assets. Correction: Intangible assets must be amortized over their useful life. Use the formula Amortization Expense = Cost / Useful Life.
3. Mistake: Not considering impairment of intangible assets. Correction: Intangible assets may be impaired due to various factors. Use the formula Impairment Loss = Carrying Value - Recoverable Amount.

Exam Tips

1. Tip: Be careful with the normal balance of intangible assets. They are recorded as assets, so they have a debit balance.
2. Tip: Remember that goodwill is the excess of the purchase price over the fair value of identifiable assets.
3. Tip: Be aware of the impairment of intangible assets, which can result in a loss.

Quick Practice

1. Problem: A company purchases a patent for $60,000. What is the adjusting entry for the first year of amortization?

Answer: Dr. Amortization Expense $6,000 Cr. Patent $6,000

Explanation: The patent is amortized over its useful life, which is 10 years.

1. Problem: A company purchases a franchise for $80,000. What is the carrying value of the franchise after 5 years of amortization?

Answer: $60,000

Explanation: The franchise is amortized over its useful life, which is 10 years. After 5 years, the carrying value would be $80,000 - ($80,000 / 10) x 5 = $60,000.

Last-Minute Cram Sheet

1. Intangible assets are recorded as assets with a debit balance.
2. Patents, copyrights, trademarks, and franchises are examples of intangible assets.
3. Goodwill is the excess of the purchase price over the fair value of identifiable assets.
4. Intangible assets must be amortized over their useful life.
5. Impairment of intangible assets can result in a loss.
6. Amortization expense is recorded as an expense and reduces the carrying value of the intangible asset.
7. The recoverable amount of an intangible asset is its fair value less costs to sell.
8. Dividends are not an expense – they go directly to retained earnings.
9. Intangible assets are not recorded as liabilities.
10. Goodwill is not amortized over its useful life.