Long-Lived Nonmonetary Assets and Their Amortization

(Part Two)

Sherinne Christie Ann Z. Albao

Reporter, 2012

Does not represent the “accumulation” of any tangible thing. (Not money)

Funding Depreciation – is a financing transaction (unrelated to recording depreciation).

Not a means of automatically creating a fund for replacing assets.

Simply an amount of original cost than has been expense.

They are also assets of the company that owns the right to extract them. (e.g. coal, oil, minerals, gas).

Measuring the cost of these wasting assets are the same as those for tangible assets.

Full cost method Successful efforts methode.g. Petroleum

Full cost method – all exploration cost should be capitalized as asset value of the reserves during the year.

Successful efforts method – only cost incurred at discovered reserves should be capitalized and the “dry hole” costs should be an expense.

Depletion – the process of amortizing the cost of natural resources in the accounting period (same as depreciation).

A petroleum company explores 10 location, incurring costs of $ 10 million each. It discovers oil and gas at three of these locations. Full cost method – recorded as $ 100 millionSuccessful cost method – asset recorded is $ 30 million and

$ 70 million will be charged as expense.

If an oil property cost $ 250 million and is estimated to contain 50 million barrels of oil. The company produced 8 million barrels of oil for that year.

Depletion for a period = (cost of reserve/estimated no. of units, let say barrels) * no. of units extracted during the period.

= ($ 250 million/50 million barrels)* 8 million barrels

= $ 5 per barrel (depletion rate) * 8 million barrels

= $ 40 million is the total depletion for the year.

The increase in the value arising through natural process of growth or aging. (e.g. timberland, cattle, tobacco, wine and other agricultural products).

Not recognized in accounts until sold. Cost incurred in the growing or aging

process are added to the asset value.

Also an increase in the value of asset. Not the opposite of depreciation Recognized in unusual circumstances. e.g. Buying a company and current

value of assets is above book value – These assets are written up to their current value.

Increase in value is recognized in accounts only when revenue is realized.

Limited Useful Life Indefinite Useful Life Good will

Patents, Copyrights, Franchise, Licenses and Lease.

Usually converted into expense over a number of accounting periods.

The systematic allocation of the costs of these assets to the periods in which they provide benefits is called amortization.

Amortization is the same process as the depreciation of tangible assets.

Intangible Asset Term

Patents 20 years (R.A. No 8293)

Copyrights Life of author and 50 years after his or her death

Licenses Depends upon the licenses one to five years at best

Franchise Depends upon the contract

Lease Depends upon the contract

An entity developed a patent at cost of P200,000 and spent P120,000 for licensing of patent including legal fees and cost of models and drawings that accompany the registration on January 1, 2011.

Patent P 120,000.00

Research and Development Expense* P 200,000.00

Cash P320,000.00

Amortization (of Patent for 2012) P 6000.00

Patent P 6000.00

Broadcasting License and Trademarks. Recognized as long lived assets with

indefinite useful lives that are not amortized.

They are subjected to periodic impairment tests.

It is considered indefinite if there are no legal, regulatory, contractual, competitive, economic or other factors that limits its life.Intangible Term Impairment

Franchise/License

Depends upon contract

Annually

Trademark 10 years Every 10 years

The excess of acquisition cost over net assets required.

Often referred to as the most “intangible” of all intangible assets.

Not specifically identifiable, indeterminate life, inherent in continuing business and relates to an entity as a whole.

Arises as part of a purchase transaction*. Cannot be amortized under any

circumstances. Subjected to annual impairment test. Any write down due to impairment is charge to income.

Initially recorded at their cost. If acquired by purchase the cost includes

purchase price and direct attributable expenditure.

If developed internally cost also includes licensing and other legal fees. All related research and development cost is expense*

Any engineering and consulting costs to develop the patent and design changes require by the patent authority is patent cost.

Technology-based intangible asset Legal fees and other costs of successfully

prosecuting or defending a patent is expense.

If litigation is unsuccessful, the legal and remaining costs of the patent is written as loss.

Can be renewed for life extension as a new patent with improvement and changes.

Useful life limited by agreement and law. But due to technological advancement or

other reasons, practical life will be shorter than legal age.

Also initially recorded at their cost. Artistic related intangible asset Cost consist of all expenses incurred in the

production of the work including those require to established or obtain the right.

If copyright is purchased the cost includes cash paid and direct attribute costs for its use.

The useful life is that period in which benefits, royalties and sales are expected.

Usually advisable to write cost of copyright against the revenue of the first printing.

Reverts the owner at the end of the period. Any improvements of the property

belonged to the owner. The useful life of the improvements

corresponds to the period of the lease. Even though improvements are

capitalized, the useful life of these improvements is not determined by the physical characteristics of the improvement but by the terms of the lease agreement.

Same as prepaid expenses. Included as long-lived assets only if they

have a relatively long life. Long-lived assets subject to amortization

are deferred charges in the literal sense. Restricted to long-lived tangibles. Some companies charge them as

expense even though there is no offsetting revenue.

Cost incurred to developed new knowledge, products or innovations, services and processes.

Can help increase revenues or lower cost.

Discussed in detailed in Chapter 12.

Average age of depreciationAccumulated depreciation/Annual Depreciation Expense

Asset’s depreciation periodCost/ Annual depreciation expense

Annual expenditure for an intangible assetAnnual amortization expense +/- increase or decrease in asset’s balance.

Anthony, Robert N., et.al. Accounting: Text and Cases 13th Edition, (McGraw-Hill Companies, Inc © 2011), pp. 186-198.

Valix, Conrado T., et.al. Financial Accounting: 2010 Volume One, (GIC Enterprises & Co., Inc. © 2010), pp. 1125-1239.

www.ipophil.giv.ph, Intellectual Property of the Philippines Website, (Philippine Government., © 2012), Last access: July 19, 2012.

Long-Lived Nonmonetary Assets

and Their AmortizationProblem 7-1Problem 7-4Case 7-2

Machine cost: $ 300,000 Estimated Useful Life: 6 years Residual Value: $ 18,000 Expected number of units to be

produced during it’s useful life: 3,525,000 units

Net cost: $ 282,000

(a) Units of Production Method:= $ 282,000/3,525,000 units= $ 0.08 per unit (Depreciation Rate)

*Depreciation Charge = No. of units in Year n * Depreciation Rate

Year UnitsDepreciation

Charge*

1 930,000 $74,400.002 800,000 $64,000.003 580,000 $46,400.004 500,000 $40,000.005 415,000 $33,200.006 300,000 $24,000.00

(b) Sum-of-the-years’ digits methodSYD = n((n+1)/2)

= 6 ((6+1)/2)= 6 (7/2)= 6 (3.5)= 21

Depreciation Rate for Year 1 is 6/21.

Year

UnitsDepreciation Charge

(UPM) SYD

Depreciation Charge (SYD)

1 930,000 $74,400.00 6/21 $80,571.432 800,000 $64,000.00 5/21 $67,142.863 580,000 $46,400.00 4/21 $53,714.294 500,000 $40,000.00 3/21 $40,285.715 415,000 $33,200.00 2/21 $26,857.146 300,000 $24,000.00 1/21 $13,428.57

The units-of-production method showed a difference in depreciation charges in each year than the sum-of-the-years’ digits method.

(1) Land 80,600.00Cash 80,600.00

(2) Building 138,000.00Ordinary Shares Capital 90,000.00Notes Payable 16,000.00Cash 32,000.00

(3) Office Equipment 9,600.00Cash 9,600.00

a.Capitalized as additional cost of the additional wing of the factory building

b.Capitalized as additional cost of the additional wing of the factory building

c.The cash discount will be deducted from the Building cost

d.Capitalized as additional cost of the additional wing of the factory building

e.Capitalized as additional cost of the additional wing of the factory building

f. Expense

g. Add to Overhead Expense

h.Capitalized as additional cost of the additional wing of the factory building

Add to expense (for injuries, losses and damages)

a.The cost of the buildings will be attributed to the cost of the land

b.The cost of the razing will also be added to the cost of the land

c.The razing of the old buildings will not be charged to the cost of the land or new building.

It will be charged as loss of retirement of the old building.The new buildings will become additional assets (building) of the company

Should the accounting treatment of the old buildings and the cost of demolishing them differ from your recommendations with respect to (a) and (b) above? Why?

Yes. It differs because in the latter case the company did not sold the land and it has been assumed that it owned the buildings for a long time and whatever cost they did to demolish the old buildings could not be added to the cost of the new buildings because the retirement of the old buildings will be added as loss or expense of the retirement of the old building.

The previous case is different because the cost of the razing of the building is added to the cost of the land. Any additional cost to bring the asset to its present location or form will be added to the cost of the asset.