Plant Asset Disposals, Natural Resources, and Intangible Assets

This chapter details the events that need to be dealt with when disposing assets. There are balance sheet and income statement entries that must be recorded when getting rid of equipment by scrapping it or selling it. It also discusses intangible assets, how to record them, and how to account for their diminishing value. Many business entities will eventually have to dispose of a plant asset. When this happens, the company will either have a loss or show a gain depending on the difference between the asset's sale price and its book value. You will learn the journal entries for a variety of situations, including a gain on the sale of an asset, a loss on the sale of an asset, how to realize loss, and what to do when a fire or flood that destroys an asset.

A company accountant's role in measuring intangibles

Many assets have no physical substance. These assets are referred to as intangible. Even though these assets have no substance, the accountant still must spend time measuring the value of these assets to corporation and how these assets contribute to the cash flow of the entity.

The accountant must first place a value on something that cannot be seen by the naked eye. Then the accountant must determine if the asset is making a contribution toward cash flow of the entity (if so and how long) and finally, the accountant must determine if and when this benefit has indeed expired.

As we move ever more toward an information based economy, the percent of intangible assets to total assets also increases. In many cases, intangible assets compose a significant majority of total assets. Thus, the earning power of such companies is primarily based on the valuation of assets that cannot be seen or touched. Some intangible assets, such as human assets and internally generated intangibles, are not even recorded on the company's books. This makes it even more difficult to value the assets and determine their contribution to earnings.

Investors and analysts often compare book value per share with the market price per share for a corporation. This ratio is referred to as the price to book ratio (PB). It measures the market's beliefs about the value of net assets as compared to the recorded amount of net assets. In 1998 Tootsie Roll had a PB ratio of approximately 5.2. The recorded net assets were approximately USD 400 million, yet the market perceived Tootsie Roll to have net assets worth over USD 2,000 million. What is the nature of those unrecorded (intangible) assets? In 1998, Microsoft had a PB ratio of approximately 12.4. The real value of Microsoft's net assets exceeded those reported in the accounting records by a factor of 12.4. It is reasonable to assume that a large portion of the unrecorded assets of Microsoft must be intangible. How does the accountant value something that has no physical substance and in many cases has not been recorded? It is similar to walking around in a dark closet wearing a blindfold.

This function is closely related to the work of the plant asset accountant. Many of the same questions must be addressed when accounting for intangible assets. The question still remains, how can you measure something you cannot see?

Your study of long-term assets - plant assets, natural resources, and intangible assets - began in Chapter 10, which focused on determining plant asset cost, computing depreciation, and distinguishing between capital and revenue expenditures. This chapter begins by discussing the disposal of plant assets. The next topic is accounting for natural resources such as ores, minerals, oil and gas, and timber. The final topic is accounting for intangible assets such as patents, copyrights, franchises, trademarks and trade names, leases, and goodwill.

Note that accounting for all the long-term assets discussed in these chapters is basically the same. A company that purchases a long-term asset records it at cost. As the company receives benefits from the asset and its future service potential decreases, the accountant transfers the cost from an asset account to an expense account. Finally, the asset is sold, retired, or traded in on a new asset. Because the lives of long-term assets can extend for many years, the methods accountants use in reporting such assets can have a dramatic effect on the financial statements of many accounting periods.