Reference no: EM133081130

Accounting for intangible assets

Pics Ltd is an Australian mail-order film developer. Although the photo developing business in Australia is growing slowly, Pics Ltd has reported significant increases in sales and net income in recent years. While sales increased from $50 million in 2009 to $120 million in 2015, profit increased from $3 million to $12 million over the same period. The stock market and analysts believe that the company's future is very promising. In early 2016, the company was valued at $350 million, which was three times 2015 sales and 26 times estimated 2016 profit.

What is the secret of Pics Ltd's success? Company management and many investors attribute the company's success to its marketing flair and expertise. Instead of competing on price, Pics Ltd prefers to focus on service and innovation, including:
• Customers are offered a CD and a set of prints from the same roll of film for a set price.
• Customers are given, at no extra charge, a ‘picture index' of mini-photos of the roll.
• A replacement roll is given to every customer (at no extra charge) with every development order.
As a result of such innovations, customers accept prices that are 60% above those of competitor discount film developers, and Pics Ltd maintains a gross profit margin of around 40%.

Nevertheless, some investors have doubts about the company as they are uneasy about certain accounting policies the company has adopted. For example, Pics Ltd capitalises the costs of its direct mailings to prospective customers ($4.2 million at 30 June 2015) and amortises them on a straight-line basis over 3 years. This practice is considered to be questionable as there is no guarantee that customers will be obtained and retained from direct mailings.

In addition to the mailing lists developed by in-house marketing staff, Pics Ltd purchased a customer list from a competitor for $800 000 on 4 July 2016. This list is also recognised as a non-current asset. Pics Ltd estimates that this list will generate sales for at least another 2 years, more likely another 3 years. The company also plans to add names, obtained from a phone survey conducted in August 2016, to the list. These extra names are expected to extend the list's useful life by another year.

Pics Ltd's 2015 statement of financial position also reported $7.5 million of marketing costs as non-current assets. If the company had expensed marketing costs as incurred, 2015 net income would have been $10 million instead of the reported $12 million. The concerned investors are uneasy about this capitalisation of marketing costs, as they believe that Pics Ltd's marketing practices are relatively easy to replicate. However, Pics Ltd argues that its accounting is appropriate. Marketing costs are amortised at an accelerated rate (55% in year 1, 29% in year 2, and 16% in year 3), based on 25 years' knowledge and experience of customer purchasing behaviour.

Required
Explain how Pics Ltd's costs should be accounted for under AASB 138 Intangible Assets, giving reasons for your answer.

Question 2: Recognition of patents in a business acquisition
In their article ‘Motorola deal offers Google tax, patent benefits' Browning and Byrnes (2011) noted the following:

Google Inc's blockbuster acquisition of Motorola Mobility Holdings Inc will bring an unusual stable of tax and accounting benefits to the search-engine giant, already one of Corporate America's most savvy users of such perks. . .
By agreeing on August 15 to pay $12.5 billion in cash for struggling Motorola Mobility's vast portfolio of 17 000 patents and 7500 pending patent applications on top of its handset business and television set-top boxes, Google is building a defensive bulwark for its Android phone software, already available on Motorola phones among others. . .
The acquisition further highlights the lack of transparency in accounting rules on how intangibles such as patents, brand names and the like are valued and their worth to investors.
Google has yet to announce the value it will give Motorola's intangibles, but experts agree it will be far more than what is currently on the cell phone maker's books. In a recent filing, Motorola Mobility reported an amortized value of $176 million for its intangible assets as of July 2, 2011.
Valuing patents may be more an art than a science.
Kevin Smithen, an analyst at Macquarie Capital, an investment firm in New York, estimated the $12.5 billion purchase price represented a $4.5 billion value for Motorola Mobility's portfolio, $3.2 billion in cash the company holds, a $3 billion handset and TV set-top business, and $1.7 billion in net operating loss tax benefits it has been unable to use.
Willens [a New York accounting and tax expert] estimated the $12.5 billion deal will include $3 billion in goodwill, or the value Google expects to generate from Motorola Mobility's brand, know-how and other intangibles, not including the patents.

Required
A. Outline the accounting for identifiable intangible assets at acquisition date when there is a business combination.
B. Explain the difference in the accounting for patents by Google in comparison to that of Motorola.