Accounting 2 Dersi 2. Ünite Özet

Intangible Assets

Intangible assets are a unique kind of non-current assets that provide certain legal rights, privileges, and competitive advantages to the business1. Intangible assets don’t have a physical substance or form unlike property, plant and equipment assets. Instead, intangible assets convey special rights from patents, copyrights, licenses, trademarks, etc. and other inventive works. Besides these, intangible assets also include pre-operating costs, research and development costs and leasehold improvements.

Not having a physical substance brings confusion with receivables. Receivables also don’t have a physical substance but they give a right of a demand from other parties apart from intangible assets. Intangible asset’s value comes from the long-term rights or advantages it provides to its owner. Intangible assets are qualified by rights, privileges, and advantages of possession rather than physical existence.

Acquisition of Intangible Assets

Purchased intangible assets are recorded at their acquisition cost that is the amount that a company paid for them. In other words, the initial cost for an intangible asset includes only the purchase price. As you can realize, there is a difference between intangible assets and property, plant, and equipment assets in determining the cost. For property, plant, and equipment assets, cost includes both the purchase price of the asset and the costs incurred in designing and constructing the asset. Companies expense any costs incurred in developing an intangible asset.

Some types of intangible assets are not purchased; they can be internally developed. When an intangible asset is internally developed, it may be very difficult to evaluate it. If an intangible asset is not purchased, only some limited costs can be capitalized. The costs of these intangible assets can be measured by costs like registration fees and attorney’s fee. When a company develops its own intangible assets, it should record those types of costs as period expenses.

Intangibles are categorized as having either a limited life (definite life) or an indefinite life. A limited (definite) life means the useful life is subject to a legal limit or can be reasonably estimated. If an intangible asset has a limited life, it will be expensed through amortization. The company allocates this type of intangible asset’s cost to expense over their useful life. The process of allocating the cost of an intangible asset to expense over its useful life is referred to amortization. Amortization applies to intangibles exactly as depreciation applies to property, plant, and equipment. Amortization occurs due to the passage of time or a decline in the usefulness of the intangible asset. Intangible assets are typically amortized on a straight-line basis.

Intangible assets with indefinite life do not have legal, contractual, regulatory, economic, or competitive factors that limit the usage of the intangible asset9. Intangible assets with an indefinite life, nevertheless, are subject to an impairment test that should be performed at least annually. Impairment occurs when the fair value of an asset is lower than the book value. In other words, there has been a permanent decline in the value of the asset. If it is determined that they have lost some or all of their value in generating future cash flows (if an impairment occurs), they should be written down to their fair value; and the company records a loss in the period in which the decline is identified.

Rights consist of patents, licenses, trademarks, franchises and copyrights that are purchased by paying their prices and expenditures made for using and benefiting the powers that the governmental authorities provided to the company. When the right is acquired, the related account is debited and they are amortized according to contract durations. If there are no contracts for the right, then the amortization duration will be five years by default. The accounting for the purchase and amortization of each asset is similar.

Companies may acquire exclusive rights to produce and sell goods with one or more unique features. Such rights are granted by patents, which the federal government issues to inventors. Patents are government grants given to the holder for invention in all fields of technology providing that the invention is new, involves an inventive step and is applicable to industry. The recognition of patent depends on how it is acquired. If it is purchased, then the cost is capitalized and recognized in Patents account. The initial cost of a patent is the cash or cash equivalent price paid to acquire the patent. If patent is internally developed through research and development, the expenditures made throughout the research and development process are recorded as current operating expense in the period in which they are incurred.

The acquired patent will be reported as Intangible Assets in the non-current assets section of the balance sheet. The cost of the purchased patent is capitalized in Patents account as an intangible asset. This cost is amortized over the years of the patent’s expected useful life. Intangible assets are generally amortized by straight-line method. The cost of the intangible asset is distributed to its useful life equally. In the first example, the useful life of the patent is 10 years. The amortization is recorded by debiting an amortization expense account and crediting the patents account. A separate contra asset account is usually not used for intangible assets.

A copyright is an exclusive right granted by the government to publish, reproduce and sell a book, musical composition, film, other art works, computer programs, or intellectual property. Government grants copyrights to authors, composers, sculptors and other artists for their creations and works. Copyright belongs to the person who creates it. When a company pays the producer/author/composer, etc. to purchase the rights for reproducing, selling or composing the work, Copyrights account is debited. Amortizations of the copyrights are as same as the amortization of the patents. At the end of the year, the company will calculate the amortization rate and then the amortization expense.

Trademarks (also called trade name) are assets that represent distinctive identifications of products or services. Trademarks may consist of any signs like words including personal names, figures, colors, letters, numbers, sounds and the shape of goods or their packages, providing that such signs are capable of distinguishing the goods or services of one undertaking from those of other undertakings and being represented on the register in a manner to determine clear and precise matter of protection afforded to its proprietor. When a company purchased the right of usage of a trademark, then Trademarks account is debited for the related amount. The cost of a trademark or trade name is amortized over its useful life.

A franchise is a contractual arrangement between a franchisor and a franchisee. Franchises are privileges granted by a business to sell goods or services under specified conditions. The franchisor grants the franchisee the right to sell certain products, perform specific services, or use certain trademarks or trade names, usually within a designated geographic area.

Licenses are privileges granted by a government to use public property in performing services. A license granted by a governmental body permits a company to use public property in performing its services

Goodwill means different things to different people. Generally, it refers to a company’s good reputation and intangible assets of a business that is created from favorable attributes that relate to a company and are not attributable to any other specific asset. These include managerial skills, desirable location, good customer relations, skilled employees, high-quality products, and good relations with labor unions. A good reputation may create goodwill, but that company cannot record goodwill for its own business.

From an accounting standpoint, goodwill is the excess of the cost to purchase another company over the market value of business’s net assets (total assets minus total liabilities). Goodwill is the value paid above the net worth of the company’s assets and liabilities. Goodwill is unique. Unlike assets such as investments and plant assets, which can be sold individually in the marketplace, goodwill can be identified only with the business as a whole. Therefore, companies record goodwill only when there is an exchange transaction that involves the purchase of an entire business. Thus, goodwill is only recorded when purchasing another company. When an entire business is purchased, goodwill is the excess of cost over the fair market value of the net assets (total assets less total liabilities) acquired.

Unlike patents and copyrights, goodwill is not amortized because it is considered to have an indefinite life. Instead, the acquiring company measures the fair value of its acquired goodwill each year. If the goodwill has increased in fair value, there is nothing to record such as a gain on goodwill. However, if goodwill’s fair value has decreased, then the company records an impairment loss and goodwill must be written down.

Companies make preoperating expenditures when establishing a new business or founding a new branch or continuously expanding of the operations but in return there is no gain obtained. These kinds of expenditures are capitalized as an intangible asset named Preoperating Costs. Because the life of the company is assumed infinite, Preoperating cost are generally amortized within 5 years.

Research and Development expenditures are capitalized when the company makes expenditures for developing new technologies or products, or improves the current ones or expenditures made for similar aims. Related expenditures are capitalized by debiting in Research and Development Costs account.

Leasehold improvements account is capitalized when the company makes expenditures in order to improve the rented fixed assets or to continuously increase the economic value of the fixed asset that will be left to the owner at the end of the rental period. The expenditures made for regular maintenance of the rented fixed assets are not included in capitalization. They will be recorded as term expenses. The leasehold improvements account is capitalized because the expenditure made is for the rented estate to bring it to its intended use and also it increases the value of the estate.

Natural Resources

Natural resources are long-term assets that come from the earth that are consumed such as Timberlands, Oil and Gas Reserves, and Mineral Deposits. These long-lived productive assets have two distinguishing characteristics:

1. they are physically extracted in operations (such as mining, cutting, or pumping), and
2. they are replaceable only by an act of nature.

These assets are converted to inventory by cutting, pumping, mining, or other extraction methods. They are recorded at acquisition cost. The acquisition cost of a natural resource is the price needed to acquire the resource and prepare it for its intended use. For an alreadydiscovered resource, such as an existing coal mine, cost is the price paid for the property.

As a natural resource is extracted, harvested, or mined and then sold, its asset account must be proportionally reduced. For example, the carrying value of oil reserves on the balance sheet is reduced by the proportional cost of the barrels pumped during the period. As a result, the company is using up the oil reserves such that at some point in time, there is nothing left to extract. The allocation of the natural resources’ cost to expense in a rational and systematic manner over the resource’s useful life is called depletion.

Financial Reporting for Intangible Assets and Natural Resources

In the balance sheet, each class of long term assets (noncurrent assets) should be disclosed on the main body of the statement or in the notes. Companies disclose the balances of the major classes of tangible and intangible long term assets either in the face of the statement or in the notes of financial statements. In addition, they should describe the depreciation, amortization, and depletion methods that were used, as well as disclose the amount of depreciation, amortization, and depletion expense for the period.

Intangible assets are usually reported in the balance sheet in a separate section following Property, Plant and Equipment assets. The balance of each class of intangible assets should be disclosed on the balance sheet at their book value (cost less accumulated depreciation) either in the face of the statement or the notes. Intangibles do not usually use a contra asset account like the contra asset account Accumulated Depreciation used for plant assets. Instead, companies record amortization of intangibles as a direct decrease (credit) to the asset account. Amortization expense is reported on the income statement as part of operations.