Question

In 2021 McGoy Ltd decided to develop a surfboard out of a new type of material that was resistant to damage. The materiai to be used was more like plastic than the fibreglass traditionally used on surfboards. In 2021 McGoy Ltd spent $510000 on research aimed at understanding the properties of different types of plastics. This knowedge provided what the company considered to be a significant breakthrough, which if utilised should lead to significant future economic benefits. In 2022 McGoy Ltd developed a prototype of its surboard. It asked several leading surfers to ride its surfboard at the annual Rip Curt Pro Event at Bells Beach. The costs involved in developing the prototype in 2022 were $780000. The reaction to the new surfboard was positive and many major retailers put in orders for the board. Anticipating the demand. McGoy Lid had spent $25000 on legal costs to register a patent for the board. The patent has a life of five years, atter which time other producers may copy the surtboard design. It became apparent that demand for this new surtboard was huge and, within four months, orders for over \$40 million dollars'. Pape 320 . Because of the positive reaction, in 2023 McGoy Ltd undertook worldwide marketing of the surlboard at a cost of $2200000. worth of the boards had been received McGoy Ltd employed a firm of accountants to work out the present value of the new surfboard and they believed that the product had a present value of at least $200 million. The managing director of McGoy Lid then decided that he would like to have the present value of the surfboard reflected in the company's financial statements, that is, he wanted it to be valued at its fair value. While his accountants considered that the present value was $200 million, a major competitor made a legally binding offer to buy the patent for the product at a price of $150 million. Describe how to account for the above transactions and events and provide appropriate journal entries.

Answer 1

McGoy Ltd should account the $510,000 research expenditure as an expense, capitalize the $780,000 prototype development and the $25,000 patent registration as intangible assets, and expense the $2,200,000 marketing costs. An offer to buy the patent cannot change its initial cost valuation in the financial statements.

Step-by-step explanation:

McGoy Ltd's expenditure on research and development should be accounted for in accordance with the International Accounting Standards (IAS) particularly IAS 38 'Intangible Assets'. Firstly, the $510,000 on research is considered an expense and should be recognized in the income statement when incurred because it does not meet the capitalization criteria as an intangible asset. Then, the $780,000 on development of the prototype can be capitalized since it meets the criteria of being able to generate probable future economic benefits. This amount should be added to the company's intangible assets on the balance sheet. The legal cost of $25,000 for patent registration should also be capitalized as a part of the intangible asset given that the patent is controllable, identifiable, and expected to produce future economic benefits. The subsequent marketing costs of $2,200,000 are to be expensed in the income statement, as marketing costs are typically recognized as an expense.

Regarding the offer from the competitor to buy the patent for $150 million, this cannot be recognized in the financial statements, because valuation of an intangible asset is based on the cost model (historical cost or amortized cost), not on market offers or fair value. Even if the managing director wants to reflect the present value, accounting standards require intangible assets to be recorded at cost and not at their potential market value. However, such a valuation might be disclosed in the notes to the financial statements, providing investors with information about the offer.