Accounting: The Language of Business (Part 65)

“Take care of yourself, you are your most valuable asset.”

― Matshona Dhliwayo

 Fixed Assets and Intangible Asset (Part I)

by

Charles Lamson

Natural Resources

The fixed assets of some businesses include timber, metal ores, minerals, or other natural resources. As these businesses harvest or mine and then sell these resources, a portion of the cost  of acquiring them must be debited to an expense account. This process of transferring the cost of natural resources to an expense account is called depletion. The amount of depletion is determined by multiplying the quantity extracted during the period by the depletion rate. This rate is computed by dividing the cost of the mineral deposit by its estimated size.

Computing depletion is similar to computing units-of-production depreciation (from part 59). To illustrate, assume that a business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore. The depletion rate is $0.40 per ton ($400,000 / 1 million tons). If 90,000 tons are mined during the year, the periodic depletion is $36,000 (90,000 tons * $0.40). The entry to record the depletion is shown below.

Like the accumulated depreciation account, accumulated depreciation is a contra asset account. It is reported on the balance sheet as a deduction from the cost of the mineral deposit.

Intangible Assets

Patents, copyrights, trademarks, and goodwill are long-lived assets that are useful in the operations of a business and are not held for sale. These assets are called intangible assets because they do not exist physically.

The basic principles of accounting for intangible assets are like those described earlier for fixed assets. The major concerns are determining (1) the initial cost and (2) the amortization---the amount of cost to transfer to expense. Amortization results from the passage of time or a decline in the usefulness of the intangible asset. 

Patents

Manufacturers 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. These rights     continue in effect for 20 years. A business may purchase patent rights from others, or it may have obtained patents developed by its own research and development efforts.

The initial cost of a purchased patent, including any related legal fees, is debited to an asset account. This cost is written off, or amortized, over the years of the patents expected usefulness. This period of time may be less than the remaining legal life of the patent. The estimated useful life of the patent may also change as technology or consumer tastes change.

The straight-line method is normally used to determine the periodic amortization when the amortization is recorded, it is debited to an expense account and credited directly to the patents account. A separate contra asset account is usually not used for intangible assets.

To illustrate, assume that at the beginning of its fiscal year, a business acquires patent rights for $100,000. The patent had been granted 6 years earlier by the Federal Patent Office. Although the patent will not expire for 14 years, its remaining useful life is estimated as 5 years. The adjusting entry to amortize the patent at the end of the fiscal year is as follows:

Rather than purchase patent rights, a business may incur significant costs in developing patents through its own research and development efforts. Such research and development costs are usually accounted for as current operating expenses in the period in which they are incurred. Expensing research and development costs is justified because the future benefits from research and development efforts are highly uncertain.

Copyrights and Trademarks

The exclusive right to publish and sell a literary, artistic, or musical composition is granted by a copyright. Copyrights are issued by the federal government and extend for 70 years beyond the author's death. The costs of a copyright include all cost of creating the work plus any administrative or legal costs of obtaining the copyright. A copyright that is purchased from another should be recorded at the price paid for it. Copyrights are amortized over their estimated useful lives. 

A trademark is a name, term, or symbol used to identify a business and its products. For example, the distinctive red and white Coca-Cola logo is an example of a trademark. Under federal law, businesses can protect against others using their trademark by registering them for 10 years and renewing the registration for ten-year periods thereafter. Like a copyright, the legal costs of registering a trademark with the federal government are recorded as an asset. Thus, even though the Coca-Cola trademarks are extremely valuable, they are not shown on the balance sheet, because the legal costs for establishing these trademarks are immaterial. If, however, a trademark is purchased from another business, the cost of its purchase is recorded as an asset. The cost of a trademark is in most cases considered to have an indefinite useful life. Thus, trademarks are not amortized over a useful life, as are the previously discussed intangible assets. Rather, trademarks should be tested periodically for impaired value. When a trademark is impaired from competitive threats or other circumstances, the trademark should be written down and a loss recognized.

Goodwill 

In business, goodwill refers to an intangible asset of a business that is created from such favorable factors as location, product quality, reputation, and management skills. Goodwill allows a business to earn a rate of return on its investment that is often in excess of the normal rate for other firms in the same business.

Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction. An example of such a transaction is the purchase of a business at a price in excess of the net assets (assets minus liabilities) of the acquired business. The excess is recorded as goodwill and reported as an intangible asset. Unlike patents and copyrights, goodwill is not amortized. However a loss should be recorded if the business prospects of the acquired firm become significantly impaired. This loss would normally be disclosed in the Other Expense section of the income statement.

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 410-412*

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