EXERCISE 4–1 On June 30, Year 1, your client, the Vandiver Corp., is granted two patents covering plastic cartons that it has been producing and marketing profitably for the past three years. One patent covers the manufacturing process, and the other covers related products. Vandiver executives tell you that these patents represent the most significant breakthrough in the industry in three decades. The products have been marketed under the registered trademarks Safetainer, Duratainer, and Sealrite.

Your client has already granted licenses under the patents to other manufacturers in the U.S. and abroad and is receiving substantial royalties. On July 1, Year 1, Vandiver commenced patent infringement actions against several companies whose names you recognize as those of substantial and prominent competitors. Vandiver’s management is optimistic that these suits will result in a permanent injunction against the manufacture and sale of the infringing products and collection of damages for loss of profits caused by the alleged infringement. The financial vice president has suggested that the patents be recorded at the discounted value of expected net royalty receipts.

Required:

a. Explain what an intangible asset is.

b. (1) Explain what is meant by “discounted value of expected net royalty receipts.”

(2) How would such a value be calculated for net royalty receipts?

c. What basis of valuation for Vandiver’s patents is generally accepted in accounting? Give supporting reasons for this basis.

d. (1) Assuming no problems of implementation and ignoring generally accepted accounting principles, what is the preferable basis of evaluation for patents? Explain.

(2) Explain what would be the preferable conceptual basis of amortization.

e. What recognition or disclosure, if any, is Vandiver likely to make for the infringement litigation in its financial statements for the year ending September 30, Year 1? Explain.