Whats Intangible Assets? Accounting Treatment in Balance Sheet.

Intangible assets are rights, privileges, and competitive advantages that result from ownership of long live assets that do not posses any physical substance.  Many companies most valuable assets are intangible. Some widely known intangibles are Microsoft's patents. McDonald's franchises, the trade name Ipod, and Nike's trademark "swoosh".


How to do accounting for Intangible assets?
Intangible assets are recorded at cost. Its of two types, Limited life and indefinite life. In Limited life, the company allocated its cost over the useful life of the assets which is similar to depreciation. the process of allocation of such intangible assets is called as Amortization. Indefinite life of intangible assets should not be amortized. 


How Amortization is different from depreciation?


In Depreciation a separate account is opened called Accumulated depreciation Account and every year the amount depreciated is credited to that account and it is deducted to the Historical cost of the Gross block of the asset. Whereas in Amortization every year the cost of the assets get reduced and the Book value is shown in the Balance sheet.


Example:
In depreciation, let say the cost of asset is $10000 and depreciation in $1000 /yr 
Every year the Accumulate Depreciation Account is credited with $1000/yr.
ie., 
1st year - $1000
2nd year - $2000
3rs year - $3000 and so on till 10th year - $10000. Which means the cost of asset become Zero and a replacement is needed.


Depreciation and Amortization Treatment in Balance Sheet:
In Fixed Assets: Every year the Gross Block of the Asset is shown the Historical Cost ie,. the cost at which the Asset has been purchased and to that the Accumulated depreciation is deducted. So every successive year the Accumulated depreciation account increases and the Book value of the asset Decreases. 
Example:
1st year:     Gross Block: $10000
                 Less: Acc Dep:   $1000
                                    -----------
                                       $9000
                                    -----------

2nd year:     Gross Block: $10000

                Less: Acc Dep:       $2000

                                         -----------

                                              $8000

                                         -----------

Journal Entry for Depreciation:

Date | Depreciation - (Asset Name) | Dr. Amount |

                   (To) Accumulate Dep A/c                       | Cr. Amount|

Amortization:

In amortization, the balance sheet is shown directly the Book value of the asset instead of opening an new account unlike in depreciation.

Journal Entry for Amortization:

Date | Amortization Expense - (Asset Name) | Dr. Amount |

                   (To) Asset Name  A/c                                              | Cr. Amount|

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What is the Need of Providing Depreciation?

The need for depreciation arises because of the following reasons:

Objects of Providing Depreciation:

a) To Calculate the True Profits:
Depreciation is an expense and becomes an important element of the cost of production. Though it is not visible like other expenses and never paid to the outside party yet it is desirable to charge depreciation on fixed assets as these are used for earning purposes; so their depreciation must be deducted out of the income earned from their use in order to calculate true profit net or loss.

b) To show true Financial Position:
Financial position can be studied from the balance sheet and for the preparation of balance sheet fixed assets are required to be shown at their true value.  If assets are shown in the balance sheet without any charge made for their use or depreciation, then their value must have been overstated in the balance sheet and will not reflect the true financial position of he business.  So, for the purpose of reflecting true financial position, it is necessary that depreciation must be deducted from the assets and then at such reduced value these may be shown in the balance sheet.

c) To make Provision for replacement of assets:
If depreciation is not provided, the profits of the concern will be overstated and can be distributed to the shareholders as dividend.  After the end of the working life of the asset, there will be no provision or funds at the disposal of the concern and hos to borrow for purchasing new assets.  Provision for depreciation is a charge to profits and loss account though depreciation is not paid.  The amount of depreciation accumulated during the working life of the asset provides additional working capital besides providing sum at the end of the working life of the asset for its replacement.

Other reasons are
d) To have some Incidental advantage
e) To have Tax advantage
f) To maintain the original monetary investment of the asset intact.

Internal Reasons:
i) Wear and Tear purpose
ii) Not using
iii) Lack of proper Maintainence
iv) Change in production formal
v) Restriction of production by government
vi) Reduction to demand of the product produced by the asset
vii) Technical progress
viii) Depletion

External Reasons:
i) Obsolescence
ii) Effluxion of Time

What is Depreciation? Reasons for Calculating Depreciation?

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What is Depreciation? Reasons for Calculating Depreciation?

What is Depreciation?
Depreciation, means a decline in the net value of the assets.  A certain percentage of Fixed asset is charged as  depreciation in the every accounting period by the the business concern for the purpose of knowing the exact value of the asset holding. The another main emphasis of the depreciation process is to match up the expenses with the revenues reported in each period.

Depreciation is a permanent, continuously diminishes in the book value of a Fixed Asset.  It is only charged on the book value of the asset, it has nothing to do with Current Market Value of the asset. Depreciation will reduces the value of the asset.

Why Depreciation is Charged?
Let say in example, A machinery is purchased at $100,000 and it is used for 5 years and now if I want to sell the machinery I get only $10,000, Why? Because it been used (Wear and Tear applies).

So If the machinery broke down, I have no funds to repair of purchase a new machinery, I am left with no option except closure of my business. For this reason only, a part of money is charged from the profit in the way of depreciation in the view of any uncertainty or Expiry of machinery.

Depreciation is charged  as an Indirect expense on the end Goods produced.

Why Depreciation is charged only on Fixed Assets not on Current Assets?
Current assets are never depreciated because it is never valued in the books of accounts since they are Direct expenses whereas depreciation is Indirect expenses. So depreciation is only charged on the Fixed assets.

What are the causes of Depreciation?

Few of the causes of depreciation are.
Physical Deterioration: It is caused mainly from wear and tear when the asset is in use and from erosion, rust, rot, and decay from being exposed to wind, rain, sun and other elements of nature.

Economic Factors:  The problem on Obsolescence and Inadequacy. Obsolescence means the process of becoming obsolete or out dated.  An old machinery though in good physical condition may be rendered obsolete by the introduction of new model which produces more than the old machinery.  Inadequacy refers to the termination of the use of an asset because of growth and changes in the size of the firm.  But obsolescence and inadequacy do not necessarily mean that the asset is scrapped.

Time Factors: There are certain assets with a fixed point of legal life such as lease, patents, and copyrights.  For instance, a lease can be entered into for any period while a patents legal life is for some years but on certain grounds this can be extended.  Provision for the consumption of these assets is called amortization rather than depreciation.

Deletion: Some assets are of wasting characters perhaps due to the extraction of raw materials from them.  These materials are then either used by the firm to make something else or are sold in their raw state to other firms.  Natural resources such as mines, quarries, and old wells come under this heading.  To provide for the consumption of an assets of wasting character is called provision for depletion.

Accident: An asset may reduce in value because of meeting of an accident.

What is the Need/Reasons of Providing Depreciation?
Whats Intangible Assets? Accounting Treatment in Balance Sheet.

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