Chapter two Assets The firms financial statement provides useful information for the stake holders, the

statement of financial position contains information about assets, liabilities and owners equity. In this chapter we are going to define asset concept explain the different types and its important role within the business. There is no more fundamental concept in accounting than assets. Assets, or economic resources, are the lifeblood of both business enterprises and notfor-profit organizations. Economic resources or assets and changes in them are central to the existence and operations of an individual entity. Both business enterprises and not-for-profit organizations are in essence resource or asset processors, and a resources capacity to be exchanged for cash or other resources or to be combined with other resources to produce needed or desired scarce goods or services gives it utility and value (future economic benefit) to an entity. Because the concept of assets is so fundamental, one would think that the issue of what is or is not an asset would have been settled long ago. All accountants claim to know an asset when they see one, yet differences of opinion arise about whether some items called assets are assets at all and should be included in balance sheets. Assets definition: The definition of assets is in Concept Statement 6, paragraph 25:1 Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Assets: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.2
1 2

FASB definitions of assets in concept statement 6, paragraph 25 Charles h. Gibson (financial reporting analysis, eighth edition)

The IASB definition An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Note that the key element is controllable not the ownership An asset is a resource controlled by the entity as a result of past events, from which future economical benefits are expected to flow to the enterprise and which can have their cost evaluated in a credible way3 An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity4 Assets: are rights or other access to future benefits controlled by an entity as a result of past transactions or events.5 If a company owns plant and equipment that will be used to produce goods and services for sale in the future, the company can expect these assets to generate cash inflows in the future. Assets: are economic resources owned by a firm that are likely to produce future benefits and are measurable with a reasonable degree of certainty.6 All of these definitions are agreed in the core idea, and now we get that to recognize assets the following criterion should be considered: 1. 2. 3. 4. Provides future economic benefits. The future benefits will be as a result of past transactions or events. Controllable by the firm. Measurable with reasonable degree of certainty.

OMF 1752/2005 definition of assets

IFRS for SMEs. 1st Floor, 30 Cannon Street, London EC4M 6XH, United Kingdom: IASB (International Accounting Standards Board). 2009. pp. 14.
5 6

ASB definition of assets(issued in December 1999) Papule Healy Bernard (business analysis and valuation)

Types of assets: Assets can be classified at different basics and depend on the nature of the business. There are two major categories of assets: 1. Current assets. 2. Noncurrent assets. Current assets: Also referred to as circulating capital and working assets and it is the asset that could reasonably be converted into cash within one year or one operating cycle.7 Current asset is one that either already is cash, or will be converted into cash within a short period of time. Those are reasonably expected to be converted into cash within one operating cycle; the key element is the flexibility to be converted within one operating cycle. Current assets are important to business because they are the assets that are used to fund day-to-day operations and pay ongoing expenses. Current assets consist of cash, marketable securities, accounts receivable, and inventories. Cash comprises both currency-bills and coins- and assets that are immediately transformable into cash, such as deposits in bank accounts. Noncurrent assets: Also known as fixed assets or long-term assets, that is, it is not expected that noncurrent assets can be converted into cash within an operating cycle. For example plant, equipment...etc.

The frank j. Fabozzi series(financial management and analysis, john Wiley & sons, the second edition)

Fixed assets: is a term used in accounting for assets and property which cant easily be converted into cash within an operating cycle.8 Include physical assets, such as plant and equipment and non physical assets such as intangibles. Where noncurrent include plant assets, intangible assets and investments. Assets that do not fit neatly into these categories may be recorded as either other assets, deferred charges, or other noncurrent. The fixed assets or noncurrent assets can be classified into two types: 1. Tangible: the word tangible means the physical substance such as building, land...etc, it cant be converted into cash within year. 2. Intangible: is an identifiable non-monetary asset without physical substance.9

Depreciation: Depreciation refers to two very different but related concepts: 1. The decrease in value of assets (fair value depreciation). 2. The allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).10 Depreciation is the periodic allocation of the cost of a tangible asset (other than land and natural resources) over the assets estimated useful life.11 Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.12 So, depreciation aims to distribute the cost of assets, less salvage value (if any), over the estimated useful life of an asset in a systematic and rational manner. It is a process of allocation, not of valuation.13

8 9

www.wikipedia.com IPSAS 31 January 2010 10 www.wikipedia.com 11 Belverd e. Needles & Marian powers & Susan v, crosson(principles of accounting, tenth edition) 12 IAS 16 (paragraph 6) 13 Financial accounting an international introduction(David Alexander & Christopher nobes, second edition)

Long known for its innovative technology and design of computers, Apple revolutionized the music industry with its digital iPod music player. The companys Success stems from its willingness to invest in research and development and long-term assets to create new products. Each year, it spends about $500 million on research and development and about $200 million on new long-term assets. Almost 40 percent of its tangible assets are long term. You can get an idea of the extent and importance of Apples long-term assets by looking at the Financial Highlights from its balance sheet. 14 APPLE COMPUTERS FINANCIAL HIGHLIGHTS The future economic benefits or services potential flowing from an intangible asset may include revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the asset by the entity. Entities, frequently expend resources, or incur liabilities, on the acquisition, development, maintenance or enhancement of intangible resources such as scientific or technical knowledge, design and implementation of new processes, or system, license, intellectual property, and trademarks (including brand names and publishing titles). The three critical attributes of an intangible asset are: 1. Identifiable. 2. Control (power to obtain benefits from the asset). 3. Future economic benefits (such as revenues or reduced future costs). Under US GAAP, intangible assets are classified into: Purchased vs. Internally created intangibles. Limited life vs. indefinite life intangibles. Classification of intangible assets based on useful life: 1. Indefinite: no foreseeable limit to the period over which the asset is expected to generate net cash flow for the entity. 2. Finite life: a limited period of benefit to the entity.
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Belverd e. Needles & Marian powers & Susan v, crosson(principles of accounting, tenth edition)

Intangible assets definitions: Non-financial fixed assets that do not have a physical substance but are identifiable and controlled by the entity through custody or legal rights.15 Intangible asset: is identifiable non-monetary asset without physical substance held for use in the production or supply of goods or services for rental to others, or for administrative purposes.16 An asset is a resource: Controlled by an enterprise as a result of past events. From which future economic benefits are expected to flow the enterprise. Some of these assets are known as deferred charges while others are the traditional intangibles, including brand names, copy rights, licenses, patents...etc. A deferred charge includes advertising, promotion, authors software development cost, organization cost and training cost...etc. An intangible asset shall be recognized if, and only if: It is probable that the expected future economic benefits or services potential that the attributable to the asset will flow to the entity. The cost or fair value of the asset can be measured reliably. An entity shall assess the probability of expected future economic benefits or services potential using reasonable and supportable assumptions that represent managements best estimates of the set of economic conditions will exist over the useful life of the asset. The importance of intangible assets: The value placed on intangibles assets, such as people, knowledge, relationships and intellectual property, is now greater proportion of the total value of most businesses than is the value of tangible assets, such as
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FASB definitions of intangibles(paragraph two) IAS 38(1999b:7)

machinery and equipment. And the creation and management of intangible assets is often essential to long-term success. As important as these assets are, most businesses owners do not have and adequate understanding of how their brand and customer bases impact the value of their businesses. The heterogeneous nature of intangible assets means that it is rarely possible to find market evidence of transactions involving identical assets. Usually the only available evidence is in respect of assets that are similar, but not identical. Some organizations rely on the ability to protect their intellectual property as means to maintain or gain competitive advantage. Others depend upon income obtained from intellectual property such as through licensing- as a resource of high margin revenues. Evidence from a number of countries suggests faster growth in investment in intangible assets than in tangibles. Many non-member economics recognize the importance of knowledge networks and markets, and the need to harness their benefits. The emerging knowledge-based economy stresses the importance of knowledge as new production factor. Even though knowledge creation has always been an important task of research organizations, investment in knowledge has also been increased in these types of organization. This entails new organizational structures and requires new forms of measurement and management. The fundamental change of companies towards knowledge based organization is indicated by several findings. The most important ones are the increased intangible investments in most western countries. However, growing markets for knowledge based products and services reflect the emerging knowledge-based economy.

Intangible investments are important for the competitiveness of research organization and industrial firms, but because of their nature they are difficult to fix manage. AQUISITION OF INTANGIBLE ASSETS Intangible assets are acquired by OUS through purchase and license, donation; or internally generated within OUS. Purchase Purchases of intangible assets are processed through the Banner FIS accounts payable system. Purchases from proprietary funds (auxiliary enterprises and service departments) are recorded directly in the general ledger as an intangible asset using a A82xx general ledger account code. Purchases from non-proprietary funds are initially charged to a 408xx operating ledger expenditure account code and subsequently capitalized in the universitys investment in plant fund. Internally Generated Outlays for internally generated intangible assets typically involve multiple invoices and multiple payments.

Payments of invoices are recorded throughout the year with a 408xx intangible asset expenditure account code in the Banner FIS operating ledger. Payroll applicable to internally generated intangible assets is also recorded in the Banner FIS operating ledger, but with the appropriate payroll expense account codes. Other costs directly associated with the internally generated intangible asset are recorded in the Banner FIS operating ledger, but with the appropriate services and supplies expense account codes.

At the end of the fiscal year, a worksheet is prepared to identify the operating ledger expenditures that should be capitalized as part of the intangible asset. The worksheet includes the expenditure amounts of the operating ledger for each combination of fund, organization, account, program, activity, and location code that should be capitalized as part of the intangible asset.

The completed worksheet is submitted to the universitys fixed assets accountant for capitalizing the expenditures to a new or existing intangible asset record in the Banner Fixed Assets system. Depending on the funding source of the expenditures made, the costs of the intangible asset are capitalized to a proprietary fund (auxiliary enterprise or service department) or the universitys investment in plant fund. The capitalization results in a credit to the E1001- NIP Change in Fixed Assets general ledger fund addition account which offsets the expenditures in the operating ledger that have been capitalized. Expenditures capitalized to an internally generated intangible asset are recorded to an in development intangible asset account code, and moved from the in development account code when the intangible asset is completed and ready for amortization. A copy of the completed worksheet is sent by the universitys fixed assets accountant to Controllers Division Accounting and Reporting for making the appropriate adjustments and reclassifications to the OUS annual financial statements.17

Measurements of intangible assets: Intangible assets are of increasing importance for the corporate value creation processes of all kind of organizations. As a result of the properties of knowledge, its value can only be measured inadequately using the tools of classical accounting, or perhaps even not measured at all. All intangible assets, whether definite or indefinite, are subject to an annual impairment test to determine if the assets justify their value on the balance sheet. If it is determined that they have lost some or all of their value in producing future cash flows, they should be written down to their fair value or to zero if they have no fair value. There are two ways to differentiate the approaches, monetary and nonmonetary measures that in turn can be split into more detail: Monetary measures: - cost approach (production cost and replacement cost) - Market approach (what the market is willing to pay) - Income approach (predicts the income and discounts it to present value)
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Oregon University, accounting for intangible assets, section: fixed assets administration, title: accounting for intangible assets NO: 55. 115

- Real options (financial value of different strategies that alternatively could be applied in a given situation) Non-monetary measures - Structural models18 - Navigator19 - Process models20

Acceptable methods for the valuation of identifiable intangible assets and intellectual property fall into three broad categories. They are market based, cost based, or based on estimates of past and future economic benefits. In an ideal situation, an independent expert will always prefer to determine a market value by reference to comparable market transactions. This is difficult enough when valuing assets such as bricks and mortar because it is never possible to find a transaction that is exactly comparable. In valuing an item of intellectual property, the search for a comparable market transaction becomes almost futile. This is not only due to lack of compatibility, but also because intellectual property is generally not developed to be sold and many sales are usually only a small part of a larger transaction and details are kept extremely confidential. There are other impediments that limit the usefulness of this method, namely, special purchasers, different negotiating skills, and the distorting effects of the peaks and troughs of economic cycles. In a nutshell, this summarizes my objection to such statements as this is rule of thumb in the sector. Cost-based methodologies, such as the cost to create or the cost to replace a given asset, assume that there is some relationship between cost and value and the approach has very little to commend itself other than ease of use. The method ignores changes in the time value of money and ignores maintenance. The methods of valuation flowing from an estimate of past and future economic benefits (also referred to as the income methods) can be broken down in to four limbs; 1) capitalization of historic profits, 2) gross profit
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Intangible Asset Monitor by Sveiby 1997 and the Skandia Edvinsson and Malone 1997) 20 European Foundation for Quality Management

differential methods, 3) excess profits methods, and 4) the relief from royalty method. 1. The capitalization of historic profits arrives at the value of IPRs by multiplying the maintainable historic profitability of the asset by a multiple that has been assessed after scoring the relative strength of the IPR. For example, a multiple is arrived at after assessing a brand in the light of factors such as leadership, stability, market share, internationality, trend of profitability, marketing and advertising support and protection. While this capitalization process recognizes some of the factors which should be considered, it has major shortcomings, mostly associated with historic earning capability. The method pays little regard to the future. 2. Gross profit differential methods are often associated with trade mark and brand valuation. These methods look at the differences in sale prices, adjusted for differences in marketing costs. That is the difference between the margin of the branded and/or patented product and an unbranded or generic product. This formula is used to drive out cash flows and calculate value. Finding generic equivalents for a patent and identifiable price differences is far more difficult than for a retail brand. 3. The excess profits method looks at the current value of the net tangible assets employed as the benchmark for an estimated rate of return. This is used to calculate the profits that are required in order to induce investors to invest into those net tangible assets. Any return over and above those profits required in order to induce investment is considered to be the excess return attributable to the IPRs. While theoretically relying upon future economic benefits from the use of the asset, the method has difficulty in adjusting to alternative uses of the asset. 4. Relief from royalty considers what the purchaser could afford, or would be willing to pay, for a licence of similar IPR. The royalty stream is then capitalized reflecting the risk and return relationship of investing in the asset. Discounted cash flow (DCF) analysis sits across the last three methodologies and is probably the most comprehensive of appraisal techniques. Potential profits and cash flows need to be assessed carefully and then restated to present value through use of a discount rate, or rates. DCF mathematical modeling allows for the fact that 1 Euro in your pocket today is worth more than 1 Euro next year or 1 Euro the year after. The

time value of money is calculated by adjusting expected future returns to todays monetary values using a discount rate. The discount rate is used to calculate economic value and includes compensation for risk and for expected rates of inflation. With the asset you are considering, the valuer will need to consider the operating environment of the asset to determine the potential for market revenue growth. The projection of market revenues will be a critical step in the valuation. The potential will need to be assessed by reference to the enduring nature of the asset, and its marketability, and this must subsume consideration of expenses together with an estimate of residual value or terminal value, if any. This method recognizes market conditions, likely performance and potential, and the time value of money. It is illustrative, demonstrating the cash flow potential, or not, of the property and is highly regarded and widely used in the financial community. The discount rate to be applied to the cash flows can be derived from a number of different models, including common sense, build-up method, dividend growth models and the Capital Asset Pricing Model utilizing a weighted average cost of capital. The latter will probably be the preferred option. These processes lead one nowhere unless due diligence and the valuation process quantifies remaining useful life and decay rates. This will quantify the shortest of the following lives: physical, functional, technological, economic and legal. This process is necessary because, just like any other asset, IPRs have a varying ability to generate economic returns dependent upon these main lives. For example, in the discounted cash flow model, it would not be correct to drive out cash flows for the entire legal length of copyright protection, which may be 70 plus years, when a valuation concerns computer software with only a short economic life span of 1 to 2 years. However, the fact that the legal life of a patent is 20 years may be very important for valuation purposes, as often illustrated in the pharmaceutical sector with generic competitors entering the marketplace at speed to dilute a monopoly position when protection ceases. The message is that when undertaking a valuation using the discounted cash flow modeling, the valuer should never project longer than what is realistic by testing against these major lives. It must also be acknowledged that in many situations after examining these lives carefully, to produce cash flow forecasts, it is often not credible to

forecast beyond say 4 to 5 years. The mathematical modelling allows for this in that at the end of the period when forecasting becomes futile, but clearly the cash flows will not fall off of a cliff, by a terminal value that is calculated using a modest growth rate, (say inflation) at the steady state year but also discounting this forecast to the valuation date. While some of the above methods are widely used by the financial community, it is important to note that valuation is an art more than a science and is an interdisciplinary study drawing upon law, economics, finance, accounting, and investment. It is rash to attempt any valuation adopting so-called industry/sector norms in ignorance of the fundamental theoretical framework of valuation. When undertaking an IPR valuation, the context is all-important, and the valuer will need to take it into consideration to assign a realistic value to the asset.