Accounting for Intangible Assets (Essay Sample)

Accounting for Intangible Assets
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Question 1
Characteristics of an intangible asset
Intangible assets are those that do have a physical form such as buildings and they are identifiable in their own right. They have several characteristics that distinguish them from other assets and make them stand on their own right. At first, they hold contractual or legal right and thus they can sue or be sued. They can be separated and sold on their own right (Wyatt & Abernethy, 2008). For instance, many businesses have a goodwill that can be sold independently. The intangible assets can be purchased on their own right or when the company is acquired or they can be developed internally. As such, the management of the company may determine whether to put the intangible assets as liabilities or capitalize them where they may place them in the balance sheet (Mohana &Muralie, 1996).
Just like other assets, intangible assets are controlled by the business, which indicates that they have the capability of gaining as a result of their use and there is a reasonable expectation that the assets can appreciate in future. Basing on this, they can be classified as long term assets (Abdulrahman, 2009).
When the intangible assets are bought, proven fair value of consideration is received or given and must be recognizable. The assets through the amortization process may be placed in the balance sheet in a process called capitalization. However, it should be noted that this type of asset is not a financial instrument (Godfrey & Lu, 2004).
If the Intangible assets are internally created and thus, the business need to directly capitalize the cost involved in their development and their expenses noted (Cheung et al, 2008).
Given the characteristics, there are several categories of intangible assets and the common ones are goodwill, technology related, marketing related, contract related, artistic related, and customer related (Matolcsy & Watt, 2006).
Pics Ltd accounting on expenditure in intangible asset
Before analyzing the question, it is imperative to analyze the recognition of intangible assets in the financial statement. At first, organizations record the cost associated with the purchase of intangible assets. However, the cost incurred in the research and development during the self creation or development of intangible assets is not capitalized. However, some internally generated intangible assets such as legal fees are usually capitalized. This indicates that some organizations have extensively valuable assets that they do not recognize in their balance sheet under the Australian Accounting Standards Board (AASB) (Cheung et al, 2008).
Accounting Standard AASB 138 on intangible assets is instrumental in stipulating the standards that govern the accounting of intangible assets. It holds that all costs be expensed whereas the development of cost are capitalized if they meet the qualification criteria. The publishing titles, customer list and brands that have been generated internally are usually not recognized. An organization can have customer portfolio that emanate from building customer loyalty and relationship who will continue to trade with the organization entity. However, when there are no legal rights that protect or control the relationship with the customers, or their loyalty, then the company has no economic benefit from the relationship or loyalty to the customers hence it cannot be termed as intangible asset (Mohana &Muralie, 1996). It is from this factor that the Pics Ltd decided to purchase the list of customers in order to obtain and control the potential customers. An intangible asset has monetary value hence customer listing fits into that category (Godfrey & Lu, 2004).
However, the absence of legal right may occur and still customer listing be considered as an intangible asset as long as the relationship between the customers and the organization are not separable and have future economic benefit. In both cases, the customer listing needs to be treated as an intangible asset in the financial statement (Abdulrahman, 2009). Pics ltd decision to purchase customer listing was erroneously posted as a non current asset and being a cost, it was supposed to be recorded as an expense and not capitalized in case of the internally generated customer list( Leo et al, 2012).
Mailing to customer does not have a definite future as it is risky and the attention and loyalty of the potential customers cannot be guaranteed. Pics ltd directly mails to potential customer and amortizes them in a straight line basis for a period of 3 years. However, since there is no guarantee of gaining their loyalty, there is lack of definite economic future, thus they should not be amortized (Leo et al, 2012).
Pics Ltd capitalizes the marketing cost instead of recording it as an expense. Since there is no enough evidence to show that it has future benefit as anticipated, it should be recorded as an expense. Recording as an expense is vital because it shows the actual position of the company and not just pushing up the profit levels of the company as in the case with capitalization (Cheung et al, 2008).
Question 2
A capitalized cost is any type of cost which is recorded in the balance sheet as part of the asset and thus it cannot be considered as an expense incurred. If the cost is capitalized, the process of amortization is undertaken in case of an intangible asset (Matolcsy & Watt, 2006).
Capitalization of a cost must meet the matching principle where one recognizes the expense at the same time when revenues that are generated by those expenses are recognized. Since the costs of capitalization are amortized during the year over a period of time, capitalizing a specific cost would affect the profit for the reporting periods in future. However, there is immediate cash flow impact if the specified cost is catered for upfront (Cheung et al, 2008).
Generally, there are two categories of assets and these are those that have future benefits and others which can be converted into others such as cash. Intangible costs that have been capitalized must have future benefit. There are several characteristics of capitalized cost and these are ability to produce benefits in the future, the useful life of the asset is beyond one year, add value to the business, and can be used for more than one purpose (Leo et al, 2012).
There are several disadvantages of capitalizing cost and they may have negative impacts on the investor confidence and ultimate profitability. This may occur in cases where the benefit anticipated when capitalizing the cost are not attained and thus may have impact in profitability and the overall integrity of the company (Wyatt &Abernethy, 2008). Additionally, if the goal of the capitalization process is not met, the profitability and solvency ratios may be low and this may affect the credit worth of the company and investors may shun it for other companies. Additionally, it may result to eroded reputation of the management team and thus the overall performance of the company. At this juncture, the chief financial officer of Pics ltd needs to give a number of convincing reasons why the marketing cost should be capitalized and not placed as an expense, which is common with most of the accounting reporting systems (Leo et al, 2012).
When marketing cost is capitalized, the pattern of reporting will be smooth due to minimal variability as that recorded under expenses. During the early years of capitalization, the company will have higher profitability than if it could have placed the marketing cost as an expense. The profitability in the latter year of capitalization of the marketing cost will be maintained because the benefit obtained as a result will supersede any negative impact. With the higher profitability, the shareholder equity will increase and thus the dividend will be high (Cheung et al, 2008).
Capitalization enhances the value of the company and ultimately the value of the asset. When the value of the company is high, its shares will become valuable and will attract many investors. Additionally, when the value of the company is high, it is likely to get financial from a number of sources as the company will be deemed as credit worth (Matolcsy & Watt, 2006).
A business that decides to capitalize its costs must follow the general accepted accounting principles that require some cost to be capitalized. Marketing cost is an example as it has a long term effects and thus it has numerous advantages in terms of tax. When the marketing cost is capitalized, the promotional tactics of the company are going to increase and thus more customers will be attracted and their loyalty to the company enhanced (Leo et al, 2012).
When the company capitalizes the marketing cost, the profitability ratio will be high. The equity turnover ration will be high while the solvency ratio will be high. This will show that the company is performing well and thus, there will be investor’s confidence in it. Additionally, it will show that the company is gaining positively from capitalization of the market cost in terms of increased number of customers and their spending on the company products (Leo et al, 2012).
Capitalization is a risky undertaking but if it succeeds well, it is likely to enhance the image of the management of the company. Undertaking a risky decision is a bold action by the management and it will show their confidence in managing the company no matter how difficulty a situation may be. As such, the chief financial officer should inform the investors that they have confidence that the decision of capitalizing marketing cost is a profitable and beneficial tactic that will spur the growth of the company just as other risky measures have been ...