ACCOUNTING FOR NONCURRENT ASSETS

Noncurrent assets are those not meeting the definition of current assets. They include a variety of
items:

Long-Term Investments

Long-term investments, often referred to simply as investments, normally consist of one of four
types:

1. Investments in securities, such as bonds, common stock, or long-term notes.

2. Investments in tangible fixed assets not currently used in operations, such as land held for
speculation.

3. Investments set aside in special funds such as a sinking fund, pension fund, or plant expansion
fund. This includes the cash surrender value of life insurance.

4. Investments in nonconsolidated subsidiaries or affiliated companies. Companies expect to hold

long-term investments for many years. They usually present them on the balance sheet just below
“Current assets,” in a separate section called “Investments.” Realize that many securities classified
as long-term investments are, in fact, readily marketable. But a company does not include them as
current assets unless it intends to convert them to cash in the short-term—that is, within a year or in
the operating cycle, whichever is longer.

Motorola, Inc, a phone manufacturing company, reported its investments section, located between
“Property, plant, and equipment” and “Other assets,” as shown in the Illustration below:

Motorola, Inc.

(in millions)

Investments

Equity investments $ 872

Other investments 2,567

Fair value adjustment to available-for-sale securities 2,487

Total $5,926

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Property, Plant, and Equipment

Property, plant, and equipment are tangible long-lived assets used in the regular operations of the
business. These assets consist of physical property such as land, buildings, machinery, furniture,
tools, and wasting resources (timberland, minerals). With the exception of land, a company either
depreciates (e.g., buildings) or depletes (e.g., timberlands or oil reserves) these assets.

Mattel, Inc, an American multinational toy manufacturing and entertainment company, presented
its property, plant, and equipment in its balance sheet as shown in the Illustration:

Mattel, Inc.

Property, plant, and equipment

Land $ 32,793,000

Buildings 257,430,000

Machinery and equipment 564,244,000

Capitalized leases 23,271,000

Leasehold improvements 74,988,000

952,726,000

Less: Accumulated depreciation 472,986,000

479,740,000

Tools, dies and molds, net 168,092,000

Property, plant, and equipment, net 647,832,000

Companies like Bidco and Safaricom use assets of a durable nature. Such assets are called property,
plant, and equipment. Other terms commonly used are plant assets and fixed assets. We use these
terms interchangeably. Property, plant, and equipment include land, building structures (offices,
factories, warehouses), and equipment (machinery, furniture, tools). The major characteristics of
property, plant, and equipment are as follows.

1. They are acquired for use in operations and not for resale. Only assets used in normal business
operations are classified as property, plant, and equipment. For example, an idle building is more

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appropriately classified separately as an investment. Land developers or sub dividers classify land as
inventory.

2. They are long-term in nature and usually depreciated. Property, plant, and equipment yield
services over a number of years. Companies allocate the cost of the investment in these assets to
future periods through periodic depreciation charges. The exception is land, which is depreciated
only if a material decrease in value occurs, such as a loss in fertility of agricultural land because of
poor crop rotation, drought, or soil erosion.

3. They possess physical substance. Property, plant, and equipment are tangible assets characterized
by physical existence or substance. This differentiates them from intangible assets, such as patents
or goodwill. Unlike raw material, however, property, plant, and equipment do not physically become
part of a product held for resale.

Acquisition of Property, Plant and Equipment

Most companies use historical cost as the basis for valuing property, plant, and equipment. Historical
cost measures the cash or cash equivalent price of obtaining the asset and bringing it to the location
and condition necessary for its intended use. Companies consider the purchase price, freight costs,
sales taxes, and installation costs of a productive asset as part of the asset’s cost. It then allocates
these costs to future periods through depreciation. Further, a company adds to the asset’s cost any
related costs incurred after the asset’s acquisition, such as additions, improvements, or
replacements, if they provide future service potential. Otherwise, the company expenses these costs
immediately. Subsequent to acquisition, companies should not write up property, plant, and
equipment to reflect fair value when it is above cost. The main reasons for this position are as
follows.

1. Historical cost involves actual, not hypothetical, transactions and so is the most reliable.

2. Companies should not anticipate gains and losses but should recognize gains and losses only when
the asset is sold.

Cost of Land

All expenditures made to acquire land and ready it for use are considered part of the land cost. Thus,
when a company like Standard Chartered Bank purchases land on which to build a new branch, its
land costs typically include (1) the purchase price; (2) closing costs, such as title to the land,
attorney’s fees, and recording fees; (3) costs incurred in getting the land in condition for its intended
use, such as grading, filling, draining, and clearing; (4) assumption of any liens, mortgages, or

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encumbrances on the property; and (5) any additional land improvements that have an indefinite
life.

Cost of Buildings

The cost of buildings should include all expenditures related directly to their acquisition or
construction. These costs include (1) materials, labor, and overhead costs incurred during
construction, and (2) professional fees and building permits. Generally, companies contract others to
construct their buildings. Companies consider all costs incurred, from excavation to completion, as
part of the building costs. But how should companies account for an old building that is on the site of
a newly proposed building? Is the cost of removal of the old building a cost of the land or a cost of
the new building? If a company purchases land with an old building on it, then the cost of demolition
less its salvage value is a cost of getting the land ready for its intended use and relates to the land
rather than to the new building. In other words, all costs of getting an asset ready for its intended
use are costs of that asset.

Cost of Equipment

The term “equipment” in accounting includes delivery equipment, office equipment, machinery,
furniture and fixtures, furnishings, factory equipment, and similar fixed assets. The cost of such
assets includes the purchase price, freight and handling charges incurred, insurance on the
equipment while in transit, cost of special foundations if required, assembling and installation costs,
and costs of conducting trial runs. Costs thus include all expenditures incurred in acquiring the
equipment and preparing it for use.

Interest Costs During Construction

The proper accounting for interest costs has been a long-standing controversy.

Three approaches have been suggested to account for the interest incurred in financing the
construction of property, plant, and equipment:

1. Capitalize no interest charges during construction. Under this approach, interest is considered a
cost of financing and not a cost of construction. Some contend that if a company had used stock
(equity) financing rather than debt, it would not incur this cost. The major argument against this
approach is that the use of cash, whatever its source, has an associated implicit interest cost, which
should not be ignored.

2. Charge construction with all costs of funds employed, whether identifiable or not. This method
maintains that the cost of construction should include the cost of financing, whether by cash, debt,

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or stock. Its advocates say that all costs necessary to get an asset ready for its intended use,
including interest, are part of the asset’s cost. Interest, whether actual or imputed, is a cost, just as
are labor and materials. A major criticism of this approach is that imputing the cost of equity capital
(stock) is subjective and outside the framework of a historical cost system.

3. Capitalize only the actual interest costs incurred during construction. This approach agrees in part
with the logic of the second approach—that interest is just as much a cost as are labor and
materials. But this approach capitalizes only interest costs incurred through debt financing. (That is,
it does not try to determine the cost of equity financing.) Under this approach, a company that uses
debt financing will have an asset of higher cost than a company that uses stock financing. Some
consider this approach unsatisfactory because they believe the cost of an asset should be the same
whether it is financed with cash, debt, or equity.

GAAP requires the third approach—capitalizing actual interest (with modification). This method
follows the concept that the historical cost of acquiring an asset includes all costs (including interest)
incurred to bring the asset to the condition and location necessary for its intended use. The rationale
for this approach is that during construction, the asset is not generating revenues. Therefore, a
company should defer (capitalize) interest costs. Once construction is complete, the asset is ready
for its intended use and a company can earn revenues. At this point the company should report
interest as an expense and match it to these revenues. It follows that the company should expense
any interest cost incurred in purchasing an asset that is ready for its intended use.

Intangible Assets

Intangible assets lack physical substance and are not financial instruments. They include patents,
copyrights, franchises, goodwill, trademarks, trade names, and customer lists. A company writes off
(amortizes) limited-life intangible assets over their useful lives. It periodically assesses indefinite-life
intangibles (such as goodwill) for impairment. Intangibles can represent significant economic
resources, yet financial analysts often ignore them, because valuation is difficult.

PepsiCo, Inc. reported intangible assets in its balance sheet as shown in the Illustration below:

PepsiCo, Inc.
(in millions)
Intangible assets
Goodwill $3,374
Trademarks 1,320
Other identifiable intangibles 147

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 Total intangibles $4,841

PATENTS. A patent is an exclusive right to manufacture a product or to use a process. In essence, the
holder of a patent has a monopoly on the use, manufacture, or sale of the product or process. If a
patent is purchased from an inventor or another individual or company, the amount paid is its initial
valuation. The cost might also include such other costs as legal and filing fees to secure the patent.
Holders of patents often need to defend a patent in court against infringement. Any attorney fees
and other costs of successfully defending a patent are added to the patent account. When a patent
is developed internally, the research and development costs of doing so are expensed as incurred.
We capitalize legal and filing fees to secure the patent, even if internally developed.
COPYRIGHTS. A copyright is an exclusive right of protection given to a creator of a published work,
such as a song, film, painting, photograph, or book. Copyrights are protected by law and give the
creator the exclusive right to reproduce and sell the artistic or published work for the life of the
creator plus 70 years. Accounting for the costs of copyrights is virtually identical to that of patents.
TRADEMARKS. A trademark , also called tradename , is an exclusive right to display a word, a slogan,
a symbol, or an emblem that distinctively identifies a company, a product, or a service. The
registration can be renewed for an indefinite number of 10-year periods, so a trademark is an
example of an intangible asset whose useful life could be indefinite. Trademarks or tradenames
often are acquired through a business combination. As an example, in 2002, Hewlett-Packard
Company (HP) acquired all of the outstanding stock of Compaq Computer Corporation for $24
billion. Of that amount, $1.4 billion was assigned to the Compaq tradename. HP stated in a
disclosure note that this “. . . intangible asset will not be amortized because it has an indefinite
remaining useful life based on many factors and considerations, including the length of time that the
Compaq name has been in use, the Compaq brand awareness and market position and the plans for
continued use of the Compaq brand within a portion of HP’s overall product portfolio.”
Trademarks can be very valuable. The estimated value of $70 billion for the Coca-Cola trademark is
a good example. Note that the cost of the trademark reported in the balance sheet is far less than
the estimate of its worth to the company. The Coca-Cola Company’s 2022 balance sheet disclosed all
trademarks at a cost of only $13.9 billion.
FRANCHISES. A franchise is a contractual arrangement under which the franchisor grants the
franchisee the exclusive right to use the franchisor’s trademark or tradename and may include
product and formula rights, within a geographical area, usually for a specified period of time. Many
popular retail businesses such as fast food outlets, automobile dealerships, and motels are
franchises. For example, the last time you ordered some chicken at KFC, you were probably dealing

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with a franchise. The owner of that KFC outlet paid KFC Corporation a fee in exchange for the
exclusive right to use the KFC name and to sell its products within a specified geographical area. In
addition, many franchisors provide other benefits to the franchisee, such as participating in the
construction of the retail outlet, training of employees, and national advertising. Payments to the
franchisor usually include an initial payment plus periodic payments over the life of the franchise
agreement. The franchisee capitalizes as an intangible asset the initial franchise fee plus any legal
costs associated with the contract agreement. The franchise asset is then amortized over the life of
the franchise agreement. The periodic payments usually relate to services provided by the franchisor
on a continuing basis and are expensed as incurred. Most purchased intangibles are specifically
identifiable. That is, cost can be directly associated with a specific intangible right. An exception is
goodwill.
GOODWILL. Goodwill is a unique intangible asset in that its cost can’t be directly associated with any
specifically identifiable right and it is not separable from the company itself. It represents the unique
value of a company as a whole over and above its identifiable tangible and intangible assets.
Goodwill can emerge from a company’s clientele and reputation, its trained employees and
management team, its favorable business location, and any other unique features of the company
that can’t be associated with a specific asset. Because goodwill can’t be separated from a company,
a buyer can’t acquire it without also acquiring the whole company or a portion of it. Goodwill will
appear as an asset in a balance sheet only when it was purchased in connection with the acquisition
of control over another company. In that case, the capitalized cost of goodwill equals the fair value
of the consideration exchanged (acquisition price) for the company less the fair value
of the net assets acquired. The fair value of the net assets equals the fair value of all identifiable
tangible and intangible assets less the fair value of any liabilities of the selling company
assumed by the buyer. Goodwill is a residual asset; it’s the amount left after other assets are
identified and valued.
Consider the following illustration:
The Smithson Corporation acquired all of the outstanding common stock of the Rider Corporation in
exchange for $18 million cash.* Smithson assumed all of Rider’s long-term debts which have a fair
value of $12 million at the date of acquisition. The fair values of all identifiable assets of Rider are as
follows ($ in millions):

Receivables $5
Inventory 7
Property, plant, and equipment 9

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Patent 4
Total $25

The cost of the goodwill resulting from the acquisition is $5 million:

Fair value of consideration exchanged $18

Less: Fair value of net assets acquired
Assets $25
Less: Fair value of liabilities assumed (12) (13)
Goodwill $5

The Smithson Corporation records the acquisition as follows:

Receivables (fair value) ..................................................................... 5
Inventory (fair value) ......................................................................... 7
Property, plant, and equipment (fair value) ..................................... 9
Patent (fair value) ............................................................................. 4
Goodwill (difference) ........................................................................ 5
Liabilities (fair value) ..................................................................... 12
Cash (acquisition price) ................................................................. 18

On October 1, 20X3, Advanced Micro Circuits, Inc., completed the purchase of Zotec Corporation for
$200 million. Included in the allocation of the purchase price were the following identifiable
intangible assets ($ in millions), along with the fair values and estimated useful lives:

Intangible Asset Fair Value Useful Life (in years)

Patent $10 5
Developed technology 50 4
Customer list 10 2

In addition, the fair value of acquired tangible assets was $100 million. Goodwill was valued at $30
million. Straight-line amortization is used for all purchased intangibles. During 20X3, Advanced
finished work on a software development project. Development costs incurred after technological
feasibility was achieved and before the product release date totaled $2 million. The software was
available for release to the general public on September 29, 20X3. During the last three months of

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the year, revenue from the sale of the software was $4 million. The company estimates that the
software will generate an additional $36 million in revenue over the next 45 months.
Required:
Compute amortization for purchased intangibles and software development costs for 20X3.

Solution:

Amortization of Purchased Intangibles:

Patent $10 million / 5 = $2 million × 3/12 year = $.5 million

Developed technology $50 million / 4 = $12.5 million × 3/12 year = $3.125 million
Customer list $10 million / 2 = $5 million × 3/12 year = $1.25 million
Goodwill The cost of goodwill is not amortized.

Amortization of Software Development Costs:

(1) Percentage-of-revenue method:
$4 million
($4 million + 36 million) = 10% × $2 million = $200,000
(2) Straight-line:
3 months
48 months or 6.25% × $2 million = $125,000

Advanced will use the percentage-of-revenue method since it produces the greater amortization,
$200,000.