• Harvard University

• ACC 1

Chapter 16: Audit of Intangible Assets

Review Questions and Exercises

1. How does the auditor ascertain the future economic benefit of recorded intangibles?

The decision whether a given expenditure on intangible asset to be treated as expense or asset

requires judgment. Expenditure giving rise to future benefits will be classified as assets while

those expenditures the future benefits from which are uncertain are charged of as expense in the

year incurred. The expected benefit from the intangible assets can be assessed in terms of the

following:

a. Patents: Actual production of the goods covered by the patent

b. Goodwill: Review of actual excess income as well as actual income of the investee

c. Trademark / Tradename: Continuous production of the product covered by the trademark /

tradename

2. Research and development expenditures should be examined as part of the audit of

intangible assets. Explain why?

Research and Development Costs vary widely among companies. Many expenditures do have

future worth, while others are so highly uncertain as to future value that recording them as assets

is clearly improper.

The auditor’s interest in auditing Research and Development costs stems from the objective

of determining whether they should be deferred or charged against current operations. He shall be

guided by GAAP in judging whether the client’s treatment of the Research and Development

Costs is justified or not.

3. Audit of Leaseholds: Menfro Inc., purchased a 20-year lease, paying P450,000 for it at the

time of purchase. Menfro amortized the lease on the straight-line basis and charged

expenses for P27,500 each year for 12 years. During the 13th year, an operating loss was

incurred to the extent of P20,000 by including P27,500 as lease amortization expense. If the

P20,000 loss was closed to retained earnings, that account would be almost depleted after

the regular dividend was declared. Menfro therefore decided to charge nothing off the lease

for the current year, thereby showing a P7,500 net income. Management called upon you to

approve the plan. What do you suggest in view of the past amortization policy of the

company?

The rapid amortization of the leasehold for the first twelve (12) years resulted to an

understatement of income totaling to P60,000:

Correct amortization (P450,000/20) x 12 P270,000

Amortization per client (P27,500 x 12) 330,000

Over-amortization P60,000

In view of the above, the amount of P60,000 should be added back to Retained Earnings as

correction of prior years’ profits. Furthermore, amortization of P22,500 for the 13th year should

be recorded.

These adjustments would result to a net increase in the Retained Earnings balance which will

enable the company to declare dividends without depleting the Retained Earnings balance

significantly.

Exercises

Exercise 1: Audit of Leasehold Improvement