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Satellite Systems modified its model Z2 satellite to incorporate a new communication device. The company made the following expenditures:

Basic research to develop the technology	$	3,600,000
Engineering design work		1,120,000
Development of a prototype device		560,000
Testing and modification of the prototype		360,000
Legal fees for patent application		76,000
Legal fees for successful defense of the new patent		36,000
Total	$	5,752,000

During your year-end review of the accounts related to intangibles, you discover that the company has capitalized all the above as costs of the patent. Management contends that the device represents an improvement of the existing communication system of the satellite and, therefore, should be capitalized.

Required:

1. Determine the amount Satellite Systems should capitalize to the Patent account in the balance sheet.

2. Determine the amount Satellite Systems should report as research and development expense in the income statement.

Answer 1

1. Only legal fees for patent application and defense will be included in patent cost. Because other costs are part of research and development.

Hence amount to be capitalized in patent account

= $76000 + $36000

= $112000

2. Amount to be recorded as research and development expense

= $3600000 + $1120000 + $560000 + $360000

= $5640000

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