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Accounting Patent Asset
Managerial Accounting Report
Alpha Ltd, which has purchased a patent to use software for use in controlling its manufacturing machinery for £50,000, will have to recognize the patent as an asset. If the patent was developed internally by Alpha Ltd it would expense the research and development costs, as opposed to recognizing an asset; but this does not apply in the case of purchased patents.
FASB’s criteria for treating expenditure as an asset are “a firm has acquired the rights to future use of a resource as a result of a past transaction or exchange” (Stickney and Weil, pg. 419). And in practice it must also be possible to measure or quantify the future benefits with a reasonable degree of precision.
Alpha estimates that it will save £8,000 in operating costs annually, for the next five years, due to the purchase of the patent. In this case both criteria to recognize an asset are met. The patent, which was acquired externally, will go on Alpha’s balance sheet as an intangible asset.
As an asset on the balance sheet Alpha will capitalize the cost of the patent and write off or amortize the intangible asset over the estimated life of the patent. If the economic life is five years as stated, meaning once the five year period is over Alpha will receive no economic benefit from the patent, then Alpha should write the patent off in the five year period using one of the following acceptable methods under GAAP: straight-line method, production or use method. If however the benefit of the patent becomes obsolete at any time during the five year period, the total amount remaining should be written off that year.
Herbie Ltd is using its support for local communities as a way to improve its company image and reputation, which has been very poor in the past in the locality. Its efforts have revolved around providing financial support and expertise to small start-ups within these local communities. In one such instance it has given Gustav Plenz funds to start up a company. Herbie Ltd’s contribution to Gustav Plenz’s start-up, which is focusing on writing business software, could be considered an investment in research and development since Herbie will have access to use Gustav’s software once it is written.
You can get expert help with your essays right now. Find out more...Herbie Ltd has essentially acquired the right to this resource in the future. Herbie has also asked Gustav to put priority in developing software that would be most useful (beneficial) to it. However, it is not clear what benefit Herbie will receive in a quantifiable sense from the software, thus it will not be able to capitalize the funds given as an intangible asset.
As a result, Herbie should recognize the £5,000 as a research and development expense in the year it provided Gustav with the start-up capital. Thus the investment of start-up to Gustav Plenz is considered an expense, which is a decrease in owner’s equity accompanying the decrease in net assets.
Wrecks-You-Like Ltd offers its customers a six month warranty covering repairs to the vehicles after purchase as part of the agreed price of the vehicle. The selling price of the vehicles includes the price of the warranty although it is not explicitly shown as a separate component of the selling price. Wrecks-You-Like receives a benefit from its customers, which is the price paid for the vehicle, and its warranty obligation constitutes a liability to the company.
Its past experience with previous vehicles sold and the amount needed to cover the six month warranties provides the company with a method to estimate its liability. Wrecks-You-Like can estimate how many of the customers it sells vehicles to will require service repairs under the warranty agreement and the expected cost of providing customers with the service repairs. Therefore Wrecks-You-Like can reasonably measure the amount of obligation and recognize the liability as such.
Wrecks-You-Like will need to recognize the appropriate amount of the liability on its balance sheet. The amount recognized as a liability can be removed from the balance sheet once the warranty period has elapsed as a transfer to owner’s equity if repairs are not needed or in the form of an expense (i.e. repairs under warranty expense) if repairs are needed.
Grunt Ltd has decided to restructure its business to save money with effect from 1st April 2008, which will inevitably result in some job losses. As a way to ensure relevant employment legislation is complied with it has just signed a contract with a human resources consultancy firm (Goodexits Ltd) for a three month period January to March 2008 to manage the human resources aspects of the restructuring programme.
This agreement constitutes a liability for Grunt Ltd. By hiring the HR consultancy firm Grunt receives the benefit of complying with legislation during a difficult time of restructuring, in exchange for a fee of £4,000 per month for the consultants. It has the obligation to pay the £4,000 per month for the three month period in exchange for the services of the consultancy firm. When the monthly fee is paid, the amount paid ceases to be a liability to Grunt Ltd and is removed accordingly from liabilities outstanding.
Nightmare Ltd owns a fully depreciated old building which has been rented out as storage space to a local company. The local Council’s Environmental Health department has recently condemned the building as unsafe to the public. The company has to decide whether to repair the building or sell it in its current state. (The building cannot be demolished as it is a “listed building”.) Repairs have been estimated to cost £120,000 to eliminate any danger of collapse, or the building could be sold in its current state for £50,000.
Find out how our expert essay writers can help you with your work...Alternative 1: Repair the building at a cost of £120,000
This expenditure of repairing the building would restore the asset (building) to a condition where it still has service potential, meaning it could continue to be rented and provide earnings. This would not extend the service life or increase productivity of the building unless some improvements were made to the building, which was not one of the alternatives given. Therefore, any repair on the building would have to be recognised as repair expense in the time the repairs were paid for. It would be possible that a liability could be entered into if the repairs are contracted to be paid for over multiple periods.
Alternative 2: Sell the building as it is for £50,000
If Nightmare Ltd sells the building it would receive cash that would be recognized as a current asset and increase owner’s equity.
Grabz Ltd owns a parcel of land which it purchased some years ago at a cost of £6,000. It has applied for residential planning permission on the land and expects the site to increase in value substantially when planning permission is granted. The directors think that the land could be worth up to £110,000 with planning permission but our firm knows that the directors of Grabz have been hopelessly inaccurate with estimated figures in the past.
Indeed the parcel of land Grabz Ltd owns will most likely increase in value due to granting of planning permission. However, how would they treat this on their financial statements, in particular how should it revalue its tangible long lived asset? Ideally firms would like to estimate the increase in value, as Grabz Ltd did here with a new estimated value of £110,000, and revalue the asset in their books as such but this is incorrect.
GAAP do not permit firms to write up the book value of their tangible or intangible long lived assets when market value increases (Stickney and Weil, pg. 440). This is not allowed due to “conservatism”. “Accountants are reluctant to recognize increases in market value until the firm sells the assets, thereby realizing and validating the value increase” (Stickney and Weil, pg. 440).
This conservative approach makes much sense when we realize that the value of land can change quite rapidly and the true determinant of the value is the market prevailing price, which can be quite difficult to speculate on. In this case we know that Grabz Ltd has a very poor history of estimating values, so this form of conservatism suits them well in particular. Through the sale of any asset we can determine the true value it has, as noted above it is realized and validated. It is easier to determine a value of land which is in use and provides returns in terms of revenue, such as rental space, etc., but in this case all we have is a plot of land.
References
Stickney, C.P., Weil, R.L. (2003), Financial Accounting: Concepts, Methods, and Uses. 10ed, Thomson Learning, Ohio.
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