Johnson Corporation purchased all of the outstanding common stock of Smith Corporation for $11,000,000 in cash. The book value of Smith's net assets (assets minus liabilities) was $7,800,000. The fair values of all of Smith's assets and liabilities were equal to their book values with the following exceptions:
Basic research to develop the technology $2,000,000.00
Engineering design work 680,000.00
Development of a prototype device 300,000.00
Acquisition of equipment 60,000.00
Testing and modification of the prototype 200,000.00
Legal and other fees for patent application on the
new communication system 40,000.00
Legal fees for successful defense of the new patent 20,000.00
The equipment will be used on this and other research projects. Depreciation on the equipment for 2013 is $10,000.
During your year-end review of the accounts related to intangibles, you discover that the company has capitalized all of the above as costs of the patent. Management contends that the device simply represents an improvement of the existing communication system of the satellite and, therefore, should be capitalized.