Scenario 4 Intangible Assets In 2016, ChiHerbal decided to develop a new type of

Question

Scenario 4 Intangible Assets

In 2016, ChiHerbal decided to develop a new type of lavender sales bags, which were made from a new material. The material to be used was more like plastics and thus more resistant to damage than the traditional material used to make sales bags. In 2016, ChiHerbal spent $350 000 on research to gain knowledge of different plastics. ChiHerbal believed this knowledge could be utilised to bring significant future economic benefits.

In 2017, ChiHerbal developed a prototype of new sales bags and asked a number of experts on plastics materials for their opinions regarding the durability of new bags. The company incurred total costs of $528 000 in developing the prototype in 2017. The experts’ comments were positive. Some other companies even put in orders to buy new bags. Anticipating a substantial market demand, ChiHerbal spent $22 000 on legal costs to register a patent for new bags. The patent has a life of 4 years, after which time other producers may copy the bag design.

In 2018, ChiHerbal conducted a large-scale marketing campaign for new bags at total costs of $650 000. The marketing campaign indicated a huge demand for new bags. Within four months, total orders for over $2 million worth of bags were received.

ChiHerbal employed an accounting firm to estimate the present value of revenues from new bags at $15 million. The company’s Chief Financial Officer decided that he would like to have this present value of the bags recognised in the company’s financial statements at its fair value. While the accounting company determined the present value at $15 million, a major competitor of ChiHerbal made a legally binding offer to buy the patent for new bags at a price of $12 million.

Required:

Describe how to account for the events and costs incurred each year. Provide appropriate journal entries.

Note: You are expected to refer to the relevant sections and paragraphs in AASB 138 Intangible Assets in your responses to Scenario 4, where applicable.

Explanation / Answer

Intangible assets are non monetary assets which lack physical substance, this is in contrast to tangible assets such as equipment, which do have a physical presence.

Not all intangibles are intangible assets. Some intangible items such as goodwill, brands, logos, and research expenditure are generated or developed internally by a business, and are not regarded as intangible assets. Expenditure on these items is charged as an expense in the income statement as it is incurred, and does not become an an intangible asset on the balance sheet of the business.

Accounting for Intangible Assets

Intangible assets are normally purchased by the business, but there are examples of internally developed intangibles such as development costs, which can be capitalized providing there is a reasonable expectation of future revenue.

The accounting treatment for intangible assets differs depending on whether the asset has a limited (finite) useful life or an indefinite life.

The cost of intangible assets with a finite life is amortized (written off) over the shorter of its legal life or useful life.

Annual amortization expense = Cost / Useful life

A patent granted to a business for an invention or purchased from a third party, is an example of an intangible asset with a finite life.

2016

Research and Devvelopment cost account Dr $350000

To Cash Account Cr $350000

2017

Research and develoment costs Account Dr 528000

To Cash Account Cr 528000

Registration Costs Dr 22000

To Cash Account Cr 22000

2018

Selling and administrative costs Debit 650000

To Cash Account Credit 650000

Professional expenses Account Debit 15 million

To Cash Account Credit 15 million

If Chi herbal accepts the offer will suffer a loss as all costs are more than the offer price.

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