AUDITING PROBLEMS
PROBLEM 1:
The following independent situations relate to the audit of intangible assets. Answer the
question/s at the end of each situation.
Situation 1:
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. P524,000
2. Amount of impairment loss to be reported by BERNARD as of December 31, 2019.
P45,960
3. Total carrying value of BERNARD’s patents on December 31, 2019. P673,540
Situation 2:
In your audit of ACE Corp. for the year ended December 31, 2019, you found the
following items in connection with the company’s patents.
a. ACE spent P120,000 during December 31, 2018 for research and development costs
on a patent. This amount was debited to Patent Account. The company’s total cost
records disclose that it had spent a total of P141,500 for the research and
development of its patents, of which P21,500 spent in 2018 had been expensed.
b. The patents were issued on July 1, 2018. LUNA incurred P14,280 of legal expenses
in relation to the issuance.
c. On January 5, 2019, ACE paid a retainer of P15,000 for legal services in connection
with a patent infringement suit brought against it. Deferred costs was charged for the
amount.
d. In reply to your inquiry about the company’s liabilities as of December 31, 2019, you
received a letter from the company’s legal counsel dated January 20, 2020, which
indicated that a settlement of the patent infringement suit had been arranged. The
plaintiff will drop the suit and release the company from all future liabilities in
exchange for P20,000. Additional lawyer’s fees were incurred amounting to P1,260.
Provide the adjusting journal entries for each item above. Net Effect: Patents –
(P105,720) Legal and Professional Fees Expense - P36,260
PROBLEM 2:
ROMANO Company acquired several small companies at the end of 2018 and, based
on the acquisition, reported the following intangibles in its December 31, 2018
Statement of Financial Position:
Patent P200,000
Copyright 400,000
Tradename 350,000
Computer Software 100,000
Goodwill 900,000
The company’s accountant determines that patent has an expected life of 10 years. The
company expects to use the copyright and tradename for the foreseeable future. Also,
the accountant believes that the computer software is to be used in the company’s 120
sales offices. The company has replaced the software in 60 offices in 2019, and expects
to replace the software in 40 more offices in 2020 and the remainder in 2021.
On December 31, 2019, there are no indications of impairment of patent and computer
software. The following information relates to the other intangible assets.
a. Because of rampant piracy, the copyright is expected to generate cash flows of just
P8,000 per year.
b. The tradename is expected to generate cash flows of P15,000 per year.
c. The goodwill is associated with ROMANO’s Manufacturing unit. The cash flows
expected to be generated by the Manufacturing unit is P200,000 per year for the next
25 years. Carrying amount of the reporting unit is P3,000,000.
Based on the above and the results of your audit, determine the following: (Assuming
that appropriate discount rate is 5% for all items)
1. Total amortization of intangible assets in 2019. P70,000
2. Total loss on impairment in 2019. P471,220
3. Carrying amount of goodwill on December 31, 2019. P718,780
4. Carrying amount of other intangible assets on December 31, 2019. P690,000
PROBLEM 3:
LUNA COMPANY began operations on January 2, 2011. Shown below is the balances
of its INTANGIBLE ASSETS as of December 31, 2019.
Patents P1,650,000
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? P1,166,786
2. What is the carrying value of the Franchise Agreement on December 31, 2019?
P120,000
3. What is the carrying value of the Organization Costs on December 31, 2019? P0
4. What is the carrying value of Goodwill on December 31, 2019? P600,000
5. What is the total Patent amortization for 2019? P325,714
SUBSTANTIVE TESTING:
1. The most effective means for the auditor to determine whether a recorded intangible
assets possesses the characteristics of an asset is
a. Vouch the purchase by reference to underlying documentation.
b. Inquire as to the status of patent application.
c. Evaluate the future revenue-producing capacity of the intangible asset.
d. Analyze the research and development expenditures to determine that only those
expenditures possessing future economic benefit have been capitalized.
2. In auditing Intangible assets, an auditor most likely would review or recompute
amortization and determined whether the amortization period is reasonable in
support of management’s financial assertion of
a. Valuation C. Completeness
b. Existence D. Rights and obligations
3. Assuming ABC, Corp has capitalized all research and development costs associated
with patent. The auditor who is examining this account will probably
a. Confer with management regarding transfer of the amount from the balance sheet
to the income statement
b. Confirm that the patent is registered and on file with the intellectual property
office.
c. Confer with management regarding a change in the title of the account to
“Goodwill”
d. Confer with management regarding ownership of the patent.
4. Which of the following comparisons would be the most appropriate audit test for the
amount of recorded goodwill?
a. The purchase price and the assigned book value of net tangible and identifiable
assets purchased.
b. The purchase price and the assigned fair value of net identifiable assets
purchased.
c. The purchase price and the assigned fair value of net tangible and identifiable
assets purchased.
d. Earnings in excess of 5% of net assets for the past five years.
5. A corporate balance sheet indicates that one of the corporate assets is a patent. An
auditor will most likely obtain evidence regarding the continuing validity and
existence of this patent by obtaining a written representation from
a. Patent attorney. C. The patent inventor.
b. SEC d. The patent owner.
