Morris Mining

Case 9.5 Morris Mining Corporation

1. Can firms record goodwill when they have purchased an asset like a patent?

No, firms cannot record goodwill when they have purchased an asset like a patent. According to ASC 350, “the excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill”. When a firm acquired another firm with a purchase price higher than the fair value of the net asset, the difference is recorded as goodwill. Goodwill is classified as intangible asset. In Morris Mining case, the company purchased King Corporation, the excess difference between purchase price and the fair value of the net asset of King Corporation should be recognized as goodwill and recorded in the intangible asset section on the balance sheet. The patent for Extract-o-Matic 1000 mining machine should be recognized as an intangible asset as well and recorded on the balance sheet.

1. Can the external auditors require them to use a method other than discounted cash flow models?

No, the external auditors cannot require them to use a method other than discounted cash flow models. GAAP doesn’t specify methods or processes for measuring items at fair value; however, GAAP indicates that the company should estimate the fair value based on observable market prices. If the observable market prices are not available, the management should incorporate assumptions that individuals in the market would use to estimate the fair value. If that information is not available, then GAAP permits the management to use its own assumptions as long as there is no indication that other participants would use different assumptions. In Morris Mining case, the company adopted the discounted cash flow method because the similar patent for this type of mining machine is not available on the active market, thus the market approach that focused on the sales of similar patent and the cost approach that focused on replacement cost did not fit for the situation. For the discounted cash flow method, the key inputs were the expected life of the asset, the discount rate, royalties on sales, and projected sales growth. Projected sales and remaining life of the patent could be gathered and estimated from the past experience. The discount rate was observable from the active market. In conclusion, the external auditor cannot require them to use a method other than discounted cash flow method in this case.

1. Are patents subjected to impairment testing?

It depends. Patents are subjected to impairment testing when it is not amortized. ASC 350-30-35-17 says “if an intangible asset that is not being amortized is subsequently determined to have a finite useful life; the asset shall be tested for impairment”. Although the patent is estimated to have a 10 year remaining life, due to the risk of technology development, the Extract-o-Matic 1000 mining machine may be replaced by competitive products sooner than 10 years. The firm should test the patent for impairment on annual basis until a definite years of life is determined. An impairment loss should be recognized to reflect the fair market value. Once the life of the patent is determined, the company will then amortize the patent over its remaining life.