Accounting in Action: CM 2
With its continuing interest in going public, CM 2 is concerned about its level of reported
earnings. In particular, Conner and Martin have expressed concern about the amount of
research and development (R&D) expense they see on the forecasted financial
statements. They are arguing that this is all “asset development” and should be
capitalized—“putting this significant expense on the income statement is hurting the
bottom line!” In addition, Conner and Martin are also puzzled by the accounting for
goodwill and other intangibles. As Conner noted, “Intangibles don't have any physical
presence, so why should they be part of the asset base?”
Part I: Goodwill
CM 2 reports goodwill on its balance sheet. Knepp and Lopez indicate that the goodwill
was from the acquisition of small “garage-type” software development companies
purchased a few years ago. CM 2 purchased the software companies so that it could
incorporate their software into the CM 2 product line as well as to gain the expertise of
Conner and Martin argue that no amortization should be recorded for goodwill because
they have heard there is no reliable way to establish a useful life for the goodwill.
However, they also know that a number of lawsuits have been filed against companies
that have accounted for intangible assets incorrectly. So they want to know if CM 2 is
doing the right accounting in regard to its goodwill.
In addition, they have heard that company names often have “value” similar to a brand.
They believe that the CM 2 name is becoming well-known in the industry and believe
that recognizing this brand name in the financial statements makes sense for a fair
presentation. They believe that the name is worth at least $125,000. They wonder,
though, what effect the recording of this intangible will have on net income.
Write a memo to CM 2 management about the proper treatment of goodwill and
company names or brands. Remember to write for non-accountants, but include citations
of the authoritative literature so they know that you know what you are talking about.
* Part II: Research and Development Costs
In reviewing CM 2 financial projections (see Excel sheet 4a), which contains the
forecasted financial statements for 2008), you note that R&D expenses are projected to be
$200,000. Knepp and Lopez indicate that 15% of this figure is related to software costs