Written Assignment 2

Written Assignment 2

Respond to the six questions below, relating to the correct application of accounting problems, in preparation for creating a finance portfolio. In your response, be sure to demonstrate a thorough understanding or application of the finance principle.

1. Explain the process for determining whether the value of a long-lived asset has been impaired.

1. What is a patent? Does a patent’s useful life correspond to its legal life? Why or why not? Support your answer with an example.

1. How are intangible assets valued, and what are their financial statement disclosure requirements?

1. Long-lived assets can be considered future benefits to be used over a period of years. The value of these benefits in the first years may not be the same as in later years. Using a car as an example, indicate whether you agree or disagree, and why.

1. Imagine that your friend is concerned that the calculation of depreciation and amortization relies too much on the use of estimates. Your friend believes that accounting should be precise. Do you agree that the use of estimates makes accounting imprecise? Why or why not?

1. What is goodwill? Why is a company’s internally generated goodwill usually not recorded in its accounting records?

Written Assignment 2

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Written Assignment 2

1. Explain the process for determining whether the value of a long-lived asset has been impaired.

Under U.S. GAAP, testing an asset for impairment is necessary when preceding circumstances or events show that recovering the carrying value through future use may not be possible. The first step in the determination of impairment and the calculation of the potential loss involved is applying the recoverability test (Larkin & DiTommaso, 2018). Thereafter, the loss involved is measured in step two. First, check for indicators of impairment in the asset then determine its recoverable amount. Assets with specifically identifiable cash flows and are parts of Cash Generating Units (CGUs) should be identified. Goodwill should be allocated CGUs. Thereafter, the carrying amount and recoverable amount should be computed. This can be done with the aid of books of account and other comprehensive income (Larkin & DiTommaso, 2018). The balance sheet indicates the value of an impaired asset as a fair value. Loss can be extracted from the income statement as the excess of the carrying value over the fair value of the asset.

2. What is a patent? Does a patent’s useful life correspond to its legal life? Why or why not? Support your answer with an example.

According to World Intellectual Property Organization (WIPO), a patent is “a patent is an exclusive right granted for an invention, which is a product or a process that provides, in general, a new way of doing something, or offers a new technical solution to a problem” (WIPO, 2018). Useful life is the amount of time that an invention is considered useful to its proprietor. It covers how long the owner of the patent expects to utilize the patent to promote or fabricate the products protected by the patent. The patent’s legal life, on the other hand, defines the time the patent is covered by applicable regulations (upcounsel, 2021). The legal life of a patent should be between 17 and 20 years from the date that the patent application was filed, while useful life can be less or more. Therefore, useful life and legal life do not correspond. For example, an inventor can assume that an invention may remain useful for 20 years and give it a legal life of 20 years. However, after 10 years the invention may be rendered obsolete due to technological advancement making 10 years its useful life (upcounsel, 2021). Additionally, the usefulness of some properties like books and songs may go beyond 20 years.

3. How are intangible assets valued, and what are their financial statement disclosure requirements?

It is hard to value a company’s intangible assets, such as brand recognition, goodwill, patents, trademarks, copyrights, proprietary technology, and customer lists because they are not physical in nature (Kenton, 2021). To do this, factors such as a company’s average return on tangible assets, the company’s pretax earnings, and the industry’s average return on tangible assets should be considered. First, calculate the average pretax earnings for the past three years, followed by the average year-end tangible assets for the period, then the company’s return on assets (ROA) (Kenton, 2021). Calculate the average ROA for the three years. Multiply the industry average ROA by the average tangible assets to get excess ROA. Calculate the three-year average corporate tax rate. Multiply the answer by the excess return and subtract the answer from the excess return. Finally, calculate the net present value (NPV) of the after-tax excess return by taking a discount rate as the company’s cost of capital (Kenton, 2021).

4. Long-lived assets can be considered future benefits to be used over a period of years. The value of these benefits in the first years may not be the same as in later years. Using a car as an example, indicate whether you agree or disagree, and why.

Naturally, long-lived assets, such as machines, vehicles, or equipment, degrade over time. The more they are used the more they experience degradation and loss of value through wear and tear (Birt, 2020). They can also lose value through damage, maintenance, improvements, and obsolescence. For instance, a car will depreciate just by getting old and covering more mileage. As the car hit the road, they start collecting dents, mechanical wear, and dings. It can also befall accidents that can cause all-most permanent damages (Birt, 2020). Such events and circumstances lower the value of the car, hence making its end years prices lower than the first years’ prices.

5. Imagine that your friend is concerned that the calculation of depreciation and amortization relies too much on the use of estimates. Your friend believes that accounting should be precise. Do you agree that the use of estimates makes accounting imprecise? Why or why not?

I agree that the use of estimates in accounting makes accounting imprecise. Accounting estimates are approximations used to price or value items that do not have precise means of measurement (Monga, 2018). They are derived from specialized knowledge and judgment gained from a long-time experience and training. As a result, they are not based on accuracy and certainty. Most estimations are done to determine the expected future benefits and obligations of some assets and liabilities. Such estimates are subjective in nature and are reevaluated and revised when changes occur (Monga, 2018). To me, such a lack of accuracy and objectivity makes the estimated amount imprecise. However, the reliability of the method is not compromised.

6. What is goodwill? Why is a company’s internally generated goodwill usually not recorded in its accounting records?

According to Franklin (2019), Goodwill is an intangible asset that arises when another company acquires a new business. It is seen as the proportion of the purchase price that is higher than the net fair value of all the assets and liabilities included in the sale because it is calculated by subtracting the fair market value from the purchase cost of the tangible assets, the intangible assets, the liabilities (Franklin, 2019). Internally-generated good is not recorded because it is not considered a resource controlled by the entity that can append cost as a measure. Goodwill has an indefinite useful life and is therefore never amortized. It is only considered as assert if it is purchased when a company is acquiring another company (Franklin, 2019).

 

 

References

Franklin, M. G. (2019). Principles of accounting volume 1 – financial accounting. Place of publication not identified: 12^th Media Services.

Birt, J. (2020). Accounting: Business reporting for decision making. Milton, QLD: John Wiley and Sons.

Kenton, W. (2021). Calculated Intangible Value (CIV). Investopedia. https://www.investopedia.com/terms/c/civ.asp

Larkin, R. F., & DiTommaso, M. (2018). Wiley not-for-profit GAAP 2018: Interpretation and application of Generally Accepted Accounting principles. John Wiley and Sons, Inc.

Monga, R. (2018). Handbook of Accountancy. S.L.: Arihant Publishers.

upcounsel. (2021). Patent Amortization: Everything You Need to Know. https://www.upcounsel.com/patent-amortization

World Intellectual Property Organization. (2018). WIPO guide to using patent information. WIPO.