Intermediate Accounting/Assets

We're assets, Nicholai. Expendible assets... and we've just been expended.

--Carlos Olivera, in Resident Evil: Apocalypse, as written by Paul W.S. Anderson


 * See Intermediate Accounting wikibook overview

Introduction on Assets
Assets may be viewed as resources owned or controlled by an entity. They include such items as cash, accounts receivable (amounts owed to the company by customers), land, building and equipment, and supplies. Current assets are often defined as assets that are in cash, or can be converted to cash, in a relatively short period. In practice that is often defined as convertible within one year or operating cycle, whichever is longer.

Cash
Cash are currency and coins, balances in checking accounts, and items acceptable for deposits in these accounts, such as checks and money orders received from customers.

Accounts receivable
This is the receivables resulting from the sale of goods or services.This is treated as a current asset on the balance sheet.

Prepaid expenses
Prepaid expenses result from businesses making payments for goods and services to be received in the near future.

Property, plant and equipment
Property, plant and equipment are tangible, long-lived assets used in the operations of the business. Land, natural resources, buildings, furniture, equipment, and machinery are included in this category. They are listed under the asset portion of the balance sheet. One major component that comes into play with property, plant, and equipment is depreciation. Mostly for equipment and machinery things are depreciated on either a straight line, declining, sum of the years digits, or units of production balance. For natural resources they use a method similar, but it is called depletion. Accounting for these things is pretty simple. The item, or land, is listed on the books at its value and every year the calculated depreciation is taken off and that determines its book value. Many times there is an estimated life and salvage value if the company thinks it can resell the item. If not, it is disposed of and the gain or loss of the sale is recorded on the books as well as removal of the item from the books.

Figuring the cost of an item takes into consideration more than just the purchase price. Added to that would be any taxes paid, less any discounts received, cost of transportation that a company pays to bring the item to where it needs to go, and the cost of getting it ready for use. The cost of land would include any attorney fees, real estate fees, title fees, back taxes that need to be paid, and the cost of preparation for the lands intended use. Buildings also have additional costs such as legal fees and remodeling fees to prepare it for use. The same goes for natural resources. Basically any costs that are necessary to get an item or land ready to use for business is included in the cost of the item.

Questions:
1. The amount reported on the balance sheet for Property, Plant and Equipment is the company's estimate of the fair market value as of the balance sheet date. True or False?

2. Initial cost of land would include all of the following except: A. Cost of Grading B. Title Search Cost C. Recording Fees D. Property Taxes for the current period 3. Property, plants, and equipment are reported as current assets. True or False?

4. What is the most commonly used form of depreciation?

5. Would tearing down an existing building on newly purchased land qualify as a cost under property, plant, and equipment?

Answers:
 * 1) False
 * D
 * 1) False
 * 2) Straightline
 * 3) Yes

Intangible Assets
Intangible assets are assets that lack physical substance, such as patents, copyrights, trademarks, franchises, and goodwill. This classification of assets generally represents exclusive rights that provide future economic benefit to the owner.

Goodwill
Goodwill is an intangible asset that represents the unique value of a company as a whole over and above its identifiable tangible and intangible assets. Because goodwill represents the fair value of a company over and above the fair value of its net assets, its costs can’t be directly associated with any specific identifiable right, subsequently making it non-separable from the company itself. Examples of a company’s goodwill would be, its clientele, good reputation within its market, well trained employees and management team, its favorable business location, and any other unique features of the company that can’t be associated with a specific asset (Spiceland, Sepe, Nelson, Tomassini, Page 486).

As previously mentioned goodwill is the excess of the purchase price over the fair value of a company’s identifiable assets. The following example illustrates how we derive the value of goodwill for a company.

Ex) The fair value of Company X’s net assets is $500,000, and can be broken down as follows; Inventory $90,000, Receivables $70,000, Property and Equipment $200,000, and Patent $140,000. Company X’s fair value of liabilities assumed is $200,000, and the purchase price of Company X is $450,000.  By taking the difference of the fair value of net assets and fair value of liabilities assumed, the fair value of the company being purchased would be $300,000.  Because the purchase price of the company was $450,000, and the fair value of the company was $300,000, we can conclude that the difference (excess) of $150,000 represents the value of the goodwill.

Understanding how the value of goodwill is derived; it’s important to note that there is no specific identifiable cost of goodwill separate from the company itself. That being said, one would conclude that goodwill cannot be separated from a company as a whole, and therefore cannot be purchased or exchanged separately from a company as a whole. Without being separable from the company, goodwill lacks two key components of most, if not all other assets; those being the ability of “equating costs of an asset” as well as “exchangeability” of an asset.

There has been great debate for some time regarding whether or not goodwill should be classified as an asset, with opposing views centering on, equating costs and assets, exchangeability of assets, and controllability of assets (Johnson, Petrone 1998, p.7). Although these opposing viewpoints do merit some consideration, the Financial Accounting Standards board (FASB) has determined that goodwill does in fact meet the three key elements that define an asset (probable future economic benefits, obtained or controlled by an entity, from a past transaction) and consequently is to be classified as an intangible asset (FASB, 350-20-05-3).

Questions 1)	How is the value of goodwill derived?

2)	Does goodwill meet FASB’s requirements for classification as an asset?

3)	What are the key concerns from opposing viewpoints regarding the classification of goodwill as an asset?

4)	What type of asset is goodwill classified as?

5)	Would a company’s client list be an example or component of goodwill?

Impairment
An impairment loss is accrued when a sudden decrease in the value of the asset occurs.In other words, depreciation and amortization will not be able to significantly decrease the book value of the asset in accordance with its market or fair value. The codification that deals with impairment can be found at 350-10-S35 for intangible assets and at 360-10-40 tangible assets.

Testing
Operational assets that a finite life should be tested for impairment when a situation arises that causes the asset to lose value. An extreme example of one situation is when the asset is destroyed. Another example is if the asset is severely damaged. Generally, operational assets should be tested for impairment when one of the following occurs; market price is significantly decreased, legal factors cause a negative change in the asset, the asset is going to be disposed of before the end of its useful life, or a negative change in the physical condition of the asset.

However, some operational assets, such as intangible assets with infinite lives and goodwill should be tested for impairment annually.

Implementation
When measuring the impairment of an asset with a finite life, a two step process is used. The first step of the process is called the recoverability test. The recoverability test determines if an impairment loss is needed by seeing if the undiscounted future value of the cash flows from the asset is less than the book value of the asset. If the future value is lower than the current book value, an impairment loss measurement is needed. The second step is to actually measure the impairment. The impairment loss is measured by the difference between the book value and the fair value of the asset.

In the case of intangible assets with indefinite lives, the impairment loss is also the difference between the book value and the fair value of the asset. However, in order to determine whether an impairment loss is needed, future cash flows cannot be used, and the only determination is the current fair value of the asset.

Goodwill is a special category of assets and is measured in a different way than other operational assets. Impairment to goodwill is measured by the difference between book value and fair value. However, the value of goodwill is only implied, so the market value of the asset cannot be used in this determination of impairment.

Journal entries
The journal entries for the impairment loss have the following format.

Loss on impairment                    xx Accumulated depreciation               xx      Asset                                xx

Questions

 * 1) A piece of machinery has a book value of $35 million and accumulated depreciation of $10 million. The fair value of this machinery is $10 million. The future, undiscounted cash flows estimated for the machinery are $15 million. Calculate the impairment loss on the machinery.
 * 2) Prepare the journal entry needed for the calculation completed in question 1.
 * 3) How does the calculation of impairment for goodwill differ from that of other intangible assets?
 * 4) What are some possible situations that causes a company to determine if their assets are impaired?
 * 5) Where are impairment losses reported in financial statements?

Answers
Loss on impairment                    $15million Accumulated depreciation              $10million Machinery                                 $25million 3. Goodwill is considered to be a special asset. The market value of goodwill is implied, therefore it can never be used in the calculation of an impairment loss. Instead, the implied fair value of goodwill is subtracted from the book value to determine the impairment loss.
 * 1) Since the book value is more than the estimated undiscounted future cash flows for the asset, an impairment loss is needed. The fair value of $10 million is subtracted from the book value of $35 million, less the accumulated depreciation of $10 million. The impairment loss is calculated to be $15million.
 * 2) The journal entry should be:

4. It would not be cost effective for companies to measure all of their assets for impairment every year. Some situations that are used to identify when an impairment loss may be needed is when there is a major decrease in market price, legal factors cause a negative change in the asset, the asset is going to be disposed of before the end of its useful life, or a negative change in the physical condition of the asset.

5. A disclosure note is needed to describe the impairment loss. Impairment losses are also seen on the income statements, as well as the balance sheet.

Investments
Accounting methods for investments held by a firm vary according to whether the firm has control over the investee.

Trading Securities
Marked to market, and gains and losses are recognized immediately in income. Balance sheet shows fair value.

Held-to-maturity debt
Recorded at amortized cost by a schedule determined at the original investment date. Gains and losses are not recognized. Balance sheet shows amortized cost.

Available-for-sale
For other debt and securities that do not meet Trading Securities or HTM requirements. Unrealized gains and losses are not recognized in regular income, but they are recognized in "other comprehensive income". Balance sheet shows fair value.

Significant influence
Equity method is primarily used; fair value option is also available.