Chapter 1 IFA II PPE PDF

***CHAPTER ONE*** ***PLANT, PROPERTY AND EQUIPMENT*** Property, plant, and equipment are very important components of a company's assets. They include assets that a company needs to conduct its business, such as land, office buildings, factories, machinery, equipment, warehouses, retail stores, an...

***CHAPTER ONE*** ***PLANT, PROPERTY AND EQUIPMENT*** Property, plant, and equipment are very important components of a company's assets. They include assets that a company needs to conduct its business, such as land, office buildings, factories, machinery, equipment, warehouses, retail stores, and delivery vehicles. They usually are a major portion of a company's total assets. In this chapter we include a discussion of the costs of acquisition, costs subsequent to acquisition, and disposal of property, plant, and equipment and its depreciation. **Classification of operational long-term assets** - Broadly operational long-term assets are divided into tangible and intangible as it is explained below: a. Intangible - Do not have physical existence - Examples, include goodwill, copyrights, patents, trademarks, franchises, etc - b. Tangible - They do have physical existence - They are sub classified into plant assets and natural resources c. Long term investments 1. Plant assets (PPE) - - 2. Natural Resources - - - **CHARACTERISTICS OF PROPERTY, PLANT, AND EQUIPMENT** **Property, plant, and equipment are the tangible noncurrent assets that a company uses in the normal operations of its business.** Alternative terms are **plant assets, fixed assets, and operational assets.** To be included in this category, an asset must have three characteristics: 1\. ***The asset must be held for use and not for investment*:** Only assets used in the normal course of business should be included. A particular type of asset may be classified as property, plant, and equipment by one company and as inventory by another. 2\. ***The asset must have an expected life of more than one year*:** The asset represents a bundle of future services that the company will receive over the life of the asset. To be included in property, plant, and equipment, the benefits must extend for more than one year or the normal operating cycle, whichever is longer. Therefore, a company distinguishes the asset from other assets, such as supplies, that it expects to consume within the current year 3\. ***The asset must be tangible in nature*:** There must be a physical substance that can be seen and touched. In contrast, intangible assets such as goodwill or patents do not have a physical substance. Unlike raw materials, generally property, plant, and equipment do not change their physical characteristics and are not added into the product. Wasting assets are natural resources, such as minerals, oil and gas, and timber that are used up by extraction. **ACQUISITION OF PROPERTY, PLANT, AND EQUIPMENT** The major types of assets that a company includes in the category of property, plant, and equipment are land, buildings, equipment, machinery, furniture and fixtures, leasehold improvements, and wasting assets. The acquisition of an item of property, plant, and equipment raises many issues. These include the determination of the cost of an asset acquired singly or by a lump-sum purchase, with deferred payments, through the issuance of securities, or by donation. Also, in more complex situations, assets may be acquired in exchange for other assets or by self-construction. **Determination of Cost** The cost of property, plant, and equipment is the cash outlay (not the "list" price) or its equivalent that is necessary to acquire the asset and put it in operating condition. In other words, **the acquisition costs that are necessary to obtain the benefits to be derived** **from the asset are capitalized** (recorded as an asset). These costs include the contract price, less discounts available, plus freight, assembly, installation, and testing costs. As for inventory, discounts *available* should be subtracted from the cost of the asset rather than recorded as discounts *taken*, because the benefits to be received from the asset are not increased by a discount not taken. **Example: Recording the Acquisition** Assume that the Devon Company purchases a machine with a contract price of \$100,000 on terms of 2/10, n/30. The company does not take the cash discount of \$2,000, and incurs transportation costs of \$2,500, as well as installation and testing costs of \$3,000. Sales tax is 7% of the invoice price, or \$7,000. During the installation of the machine, uninsured damages of \$500 are incurred and paid by the company. The company makes the following summary journal entry to record these costs: **Machine (\$100,000 - \$2,000+\$2,500** +**\$3,000** +**\$7,000) - - - - - - 110,500** **Repair Expense - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 500** **Discounts Lost - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 2,000** **Cash - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 113,000** C **Land** **The recorded cost of land includes the:** - Purchase price - costs of closing the transaction and obtaining title, including commissions, options, legal fees, title search, insurance, and past due taxes costs of surveys - costs of preparing the land for its particular use, such as clearing, grading, and razing old buildings (net of any proceeds from salvage) when such improvements have an indefinite life A company should record the costs of improvements with a limited economic life, such as landscaping, streets, sidewalks, and sewers, in a Land Improvements account and depreciate these costs over their economic lives. Alternatively, if the local government authority is responsible for the continued upkeep of the improvements, then effectively the improvements have an indefinite economic life to the company. In this case, the company should add the costs of the improvements to the cost of the land. Since land is considered *not* to have a limited economic life and its residual value is unlikely to be less than its acquisition cost, land generally is not depreciated. LAND IMPROVEMENTS -- some of the land improvements (such as landscaping and drainage) are as indefinite economic lives as that of land, so included in the land account. However, servers, streets and sidewalls are not as indefinite as that of land unless the city administration agrees to replace them. As a result mixing them with the land may misstate the depreciation expenses. **Buildings** **The recorded cost of buildings includes:** - The acquisition/ construction price - The costs of remodeling and reconditioning - The costs of excavation for the specific building - Architectural costs and the costs of building permits - Unanticipated costs resulting from the condition of the land (such as blasting rock or channeling an underground stream) A company should expense unanticipated costs, such as a strike or a fire, associated with the construction of the building. The different treatment is justified because the avoidable costs of the unanticipated events were not necessary to obtain the economic benefits of the building. MACHINERY AND EQUIPMENT -- include several items such as furniture, fixtures, Machinery, vehicles, tools, computers, office equipment, etc. According to IAS 16 Cost elements to [exclude]: 1. Costs after asset in place and ready for use as management intended 2. Costs to open a new facility, introduce a product, move to new location 3. General and administrative overhead type costs **ACCOUNTING FOR depreciation** The company acquired the assets for their long-term revenue-generating ability. Since the company uses these assets to earn revenue, the matching principle requires that the company match the expenses of the assets' use against the revenue. Over the life of the asset, the expense is the difference between the purchase price of the asset and its residual value (that is, future selling price). **Depreciation is the process of allocating in a systematic and rational manner this total expense to each period benefited by the asset.** Land is not depreciated because it generally does not have a limited life and its residual value usually is higher than its cost. Thus, there is no expense to be recognized over the life of the asset and, therefore, no periodic cost allocation. Terms used to describe this allocation process depend on the type of asset: 1\. ***Depreciation*** is the allocation of the cost of ***tangible assets***, such as property, plant, and equipment. 2\. ***Depletion*** is the allocation of the cost of ***natural resource assets***, such as oil, gas, minerals, and timber. 3\. ***Amortization*** is the allocation of the cost of ***intangible assets***, such as patents and copyrights. It may be used as a general term to describe the periodic allocation of costs; in that case, it is synonymous with depreciation and depletion. These three terms all describe the same principle of a company allocating costs to match its expenses with revenue. However, they differ in their application to different types of assets. It is important to note that a company does ***not*** record depreciation, depletion, and amortization in an attempt to report the fair value of the asset. **FACTORS INVOLVED IN DEPRECIATION** A company considers four factors in the computation of depreciation for a period: Asset cost Service life Residual value Method of cost allocation **Asset Cost** **The cost of an asset includes all the acquisition costs a company incurs to obtain the benefits from the asset.** These costs include the contract price plus freight, assembly, installation, and testing costs. **Service Life** **The service life of an asset is the measure of the service units a company expects from the asset before its disposal.** Service life may be measured in *units of time*, such as years and months, or *units of activity or output*, such as hours of operation of a machine, tons produced for a steel mill, or miles driven for a truck. The factors that limit the service life of an asset can be divided into two general categories: ***Physical depreciation*: - include wear and tear because of operational *use*, deterioration and decay that is independent of use but is a function of *time* (such as rust), and damage and destruction.** ***Functional depreciation*: - causes limit the service life of the asset through obsolescence and inadequacy, *even though the physical life is not exhausted*.** **Residual Value** **The residual (salvage) value is the net amount that a company expects to obtain from disposing of an asset at the end of its service life.** It is the expected value of the asset at the end of its service life minus the costs of disposal, such as dismantling, removing, and selling the asset. **METHODS OF COST ALLOCATION** Accounting principles require that a company use a method of cost allocation that is "systematic and rational." ***Systematic* means that, the calculation should follow a formula** **and not be determined in an arbitrary manner. *Rational* means that the amount** **of the depreciation should relate to the benefits that the asset produces in each period.** Although these criteria may appear to be very general and to allow numerous methods, only the following methods are used frequently in practice: 1\. Time-based methods a\. Straight line b\. Declining balance (declining charge) 2\. Activity (or use) methods We discuss each of these methods in the following sections, using the data for the Betty Company shown below. **The depreciation base (depreciable cost) of the** **asset is the cost less the estimated residual value,** or \$100,000. Depreciable base = cost -- estimated salvage value The different depreciation methods all allocate the total of \$100,000 over the expected service life of the asset. However, they differ in the pattern in which the cost is allocated to each year or each unit produced. Asset information of the Betty Company: Asset cost \$120,000 Date of purchase January 1, 2006 Estimated residual value \$20,000 Estimated service life 5 years; 10,000 hours; 20,000 units 1. **Time-Based Methods** **A company should use a time-based method when the service life of the asset is affected primarily by the passage of time and not by the use of the asset.** This situation includes the physical causes of deterioration and decay and the functional causes of obsolescence and inadequacy. Two general categories of time-based methods are the straight-line method and the accelerated methods. **The straight-line method is appropriate when a company estimates that the benefits it will derive from the asset will be approximately constant each period of its life.** **The accelerated (or declining-charge) methods are appropriate when a company estimates that the benefits it will derive from the asset will decline each period.** Thus, the accelerated methods match a depreciation cost that declines each period against revenues that also are declining each period. The benefits to be derived from the asset may be measured in physical terms or in dollars of revenue. The choice of a particular accelerated method is basically arbitrary. **Straight Line** **The straight-line method allocates an equal cost to each period**. See the above example; **Straight-Line Depreciation** The formula for computing periodic straight-line depreciation is: Annual straight-line depreciation = **Declining-Balance Method** **The declining-balance methods produce a declining depreciation amount each period by applying a *constant* rate to the book value of the asset at the beginning of the period.** Also, the residual value is ignored in the calculation of the depreciation each period. However, the asset is not depreciated below the estimated residual value. The constant rate is a function of the straight-line rate. The highest rate that can be used is double the straight-line rate. Since the book value of the asset is reduced each period by the depreciation charge, the constant declining-balance rate is applied to a successively lower book value that results in lower depreciation charges each year. This process continues until the book value of the asset is reduced to its estimated salvage value, at which time depreciation is discontinued. As indicated above, various multiples are used in practice, such as twice (200%) the straight-line rate (double-declining-balance method) and 150% of the straight-line rate etc. To illustrate, assume the case of Troup Company; **Book value of Accumulated Book value** **[Year] [Asset at beginning of year] [Rate] [Depc^n^ Expense] [Dep^n^. End of year]** **2006** 2007 2008 2009 2010 Another depreciation method also solves the issue of computing the correct amount of depreciation in the last year of an asset's life. It is **the fixed-percentage-of-declining-balance method,** in which a percentage depreciation rate is calculated that is multiplied by the book value to reduce it to the residual value at the end of the service life. The depreciation rate is calculated as follows: Depreciation rate = 2(100/n) n= useful life 2. **Activity (or use) methods** **Units-of-output method** This method assumes that depreciation is a function of use or productivity instead of the passage of time. The life of the asset is considered in terms of either the output it provides (units it produces), or an input measure such as the number of hours it works. Conceptually, the proper cost association is established in terms of output instead of hours used, but often the output is not easily measurable. In such cases, an input measure such as machine hours is a more appropriate method of measuring the birr amount of depreciation charges for a given accounting period. See the case of Troup Company; Depreciation expense = x Hours this year **Component Depreciation** **According to IAS 16; significant parts (called [components]) of a depreciable item with materially different consumption patterns must be depreciated separately to more faithfully represent the consumption of the asset's service potential. IFRS requires that each part of an item of property, plant, and equipment that is significant to the total cost of the asset must be depreciated separately.** **Illustration: Ethiopian Airline purchases an airplane for €100,000,000 on January 1, 2016. The airplane has a useful life of 20 years and a residual value of €0. EAL use the straight-line method of depreciation for all its airplanes. EAL identifies the following components, amounts, and useful lives.** **Computation of depreciation expense for EAL for 2016.**  **Depreciation journal entry for 2016.** **Depreciation Expense 8,600,000** **Accumulated Depreciation---Airplane 8,600,000** **On the statement of financial position at the end of 2016, EAL reports the airplane as a single amount.** **Measurement (Valuation) of Plant Assets Costs** **Lump-Sum Purchase** A company may acquire several dissimilar assets for a single lump-sum purchase price. The purchase price is allocated to the individual assets purchased. This allocation is necessary because some of the assets may be depreciable and some not, and the depreciable assets may have different economic lives and be depreciated by different methods. **A** **company allocates the acquisition price in a lump-sum purchase based on the relative** **fair values of the individual assets.** **Example:** Suppose Sample Company pays \$120,000 for land and a building. If there is no evidence in the contract of separate prices agreed upon for the land and the building, the company allocates the \$120,000 between the two assets based on their relative fair values. The company can obtain evidence of such values from several sources, such as an appraisal or the assessed values for property taxes, if it considers those values to be reasonably accurate indications of relative market values. Suppose that an appraisal of the land and building indicates values of \$50,000 and \$75,000, respectively. Sample Company computes the cost of each as follows: **Relative Fair** **Appraisal Value Value** **Total Cost** **Allocated Cost** Land \$ 50,000 \$50,000/\$125,000 \* \$120,000 = \$ 48,000 Building 75,000 \$75,000/\$125,000 \* \$120,000 = 72,000 Total \$125,000 \$120,000 Sample Company records the land at a cost of \$48,000 and the building at a cost of \$72,000. **Deferred Payments** When a company acquires property, plant, and equipment on a deferred payment basis, such as by issuing notes or bonds or assuming a mortgage, **it records the asset at its fair** **value or the fair value of the liability on the date of the transaction, whichever is more** ***reliable*.** If neither is determinable, the company records the asset at the present value of the deferred payments at the stated interest rate, unless the stated rate is materially different from the market rate, in which case it uses the market rate. **Example:** Suppose that Antush Company purchases equipment by issuing a \$10,000 non-interest-bearing five-year note, when the market rate for obligations of this type is 12%. The note will be paid off at the rate of \$2,000 at the end of each year. Neither the fair value of the equipment nor the note is determinable directly. In this case the company values both the equipment and the note at the present value of the payments, which is \$7,210 (\$2,000 X 3.604776) the factor from Table 4 of the Time Value of Money Module for five years and a 12% rate). Antush Company records the acquisition of the equipment as follows: **Equipment 7,210** **Discount on Notes Payable 2,790** **Notes Payable 10,000** **Assets Acquired by Donation** When a company acquires property, plant, and equipment through donation (usually by a governmental unit or an individual), a strict interpretation of the cost concept would require that the asset be valued at zero. However, these transactions are defined by **APB Opinion No. 29** as nonreciprocal transfers of nonmonetary assets. A **nonreciprocal transfer** is a transfer of assets or services in one direction. A company receiving an asset in such an exchange must record it at its fair value. **Example: Donation by Governmental Unit** Suppose the city of Julesberg (a governmental unit) donates land worth \$20,000 to the Klemme Company because the company relocates its production facilities to Julesberg. The Klemme Company records this event as follows: **Land 20,000** **Donated Capital 20,000** **Example: Donation by Nongovernmental Agency** In the case of a donation by a nongovernmental unit, the company records a gain. The argument for this treatment is that receiving something of value from a nongovernmental unit (e.g., a stockholder) represents earnings to the company. For example, suppose the CEO of Hrouda Company donates a building worth \$50,000 to the company. The company records this event as follows: **Building 50,000** **Gain on Receipt of Donated Building 50,000** The company reports the gain in the other items section of its income statement. **Issuance of Securities** When a company acquires assets by issuing securities such as common stock or preferred stock, the company must determine the fair value of the transaction. In many cases two measures of fair value are available: the fair value of the asset acquired and the fair value of the securities issued. The determination of the current fair value of plant assets could be substantiated by evidence than the fair value of common stock. To illustrate this point, if equipment that was appraised Br. 350, 000 is acquired in exchange for 3, 000 shares of Br. 100 par common stock, the exchange is recorded Equipment 350, 000 Common Stock, 100 par (3, 000 x Br. 100) 300, 000 Paid-in capital in Excess of par 50, 000 **Cost incurred after initial acquisition** Some expenditure, like repairs, is made after initial acquisition. Once again the controversy of revenue versus capital expenditures arises. The rule of thumb, at least academically, is expenditures that result in additional asset services, more valuable asset services, or extension of economic life are capitalized whereas expenditures to maintain plant assets in good operating condition; such as ordinary repairs, are recognized in the current period expenses. Capital expenditures could be categorized as follows, ADDITIONS -- expenditure for new plan asset or an extension of an existing asset. As an example addition is going to be debited to respective plant asset accounts. IMPROVEMENTS/RENOVATION -- it could be seen from three different angles 1. **Suppose for example, a machine costing Br. 35,000 had no estimated residual value and an original estimated useful life of ten years, has been depreciated for 7 years. At the very beginning of the 8^th^ year, the machine was given a major overhaul costing Br. 3000. This expenditure extended the useful life of the machine 3 years beyond the original estimate. The computation of the new book value and the entry for the extraordinary repair would be as follows:** ***Solution*** **To record extraordinary repair** **Jan. 4. Accumulated Depreciation -- Machinery...............3000.00** **Cash..................................................................3000.00** ***Extraordinary repair to machinery*** **The revised annual depreciation for each of the six years remaining in the machine's useful life would be calculated as follows:** **Cost of Machine............................................. Birr 35,000** **Accum. Depreciation before extraordinary repair Br. 24,500** **Less: extraordinary repair (Debited to Accum. Depr.).... [21,500]** **Book value (carrying value) after extraordinary repair... Br.13,500** **Revised Annual periodic depreciation= ............................2,250** **6 years** 2. 3. **Disposal of plant assets** There are three modes of disposing a plant asset: retiring, selling and exchanging. Two things should have to be taken into account at the time of disposing plant assets: 1. 2. **Retirements and Selling** To illustrate, machinery was acquired for Br. 250, 000 and it has a useful life of 10 years with no salvage value. Assume straight-line method of computing depreciation. Analyze the following independent cases: Cast (1) The machinery retired at the end of its useful life. Accumulated Depreciation 250, 000 Machinery 250, 000 Conclusion -- no gain or loss is recognized Case (2) the machinery retired without proceed after eight and half year of services Accumulated Depreciation 212, 500 Loss on Retirements 37, 500 Machinery 250, 000 Conclusion -- Loss is recognized Case (3) The machinery is sold for Br. 25, 000 after eight and half year of services Cash 25, 000 Accumulated Depreciation 212, 500 Loss on sale 12, 500 Machinery 250, 000 Conclusion -- a gain or loss is recognized on sale of plant assets with some recovery of net residual value. **Exchanges** The exchange could be carried out with: - - - I. a. Exchanged for new plant asset with current fair value of Br. 3, 000. b. Exchanged for new plant asset with current fair value of Br. 10, 500 Conclusion -- a gain of Br. 5, 500 (i.e. 10, 500 -- 500) is not recognized because the earning process is not complete. II. c. d. Conclusion -- loss is recognized whenever it arises e. Conclusion -- A gain of Br. 5, 200 (Br. 10, 200 i.e FV of old -- Br. 5, 000 i.e. BV of old) has not been recognized, because here cash is paid not received. f. Plant Asset (old) 30, 000 Gain on Exchange 400 Conclusion -- part of the gain is recognized by the cash receiving party, which is calculated as, Gain Recognized = Total gain x In our example, the total gain is Br. 5, 000 (Br. 10, 000 i.e. FV of old -- Br. 5, 000 i.e book value of old). Therefore, Gain recognized = Br. 5, 000 x = Br. **Depletion of natural resources** Depreciable plant assets usually retain their physical characteristics as they are used in operations. In contrast, natural resources in essence are long-term inventories of material that will be removed physically from their sources. Examples of such resources are oil, gas, minerals, timber, and gravel. #### Estimate of Recoverable Units The estimate of economic lives for plant assets is a relatively simple undertaking compared with the estimate of recoverable units of natural resources. The recoverable deposit of a natural resource should be measured in units of desired product, such as an ounce of silver or a pound of copper rather than in units of mined product, such as a ton of raw ore. The most widely method of depletion for financial accounting is the output (units-of-production) method, which produces a constant depletion charge per unit of the natural resource removed. To illustrate, assume that early in year 7, Low Company acquired mining property for Br. 720, 000. It is estimated that there are 1.2 million recoverable units of the natural resource, and that the land will have a net residual value (after restoration costs) of Br. 60, 000 when the resource is exhausted. The depletion per unit of output is computed as follows: Depletion = = = Br. 0.55 per unit If Low Company removed 300, 000 units of the natural resources from the ground in year 7, the journal entry to record depletion is as follows: Depletion (300, 000 x Br. 0.55).........................165, 000 Accumulated depletion of mining property...............165, 000 When additional costs are incurred in the development of mining properties or estimates of recoverable units are revised, the depletion rate is computed by dividing the carrying amount (cost less accumulated depletion, less net residual value) of the mining property (including any additional development costs) by the new estimate of recoverable units. **INTANGIBLE ASSET ISSUES** **Characteristics** **The Coca- Cola Company**'s success comes from its secret formula for making Coca-Cola, not its plant facilities. **America On lin**e's subscriber base, not its Internet connection equipment, provides its most important asset. The U.S. economy is dominated by information and service providers. For these companies, their major assets are often intangible in nature. What exactly are intangible assets? **Intangible assets** have two main characteristics. 1\. ***They lack physical existence.*** Tangible assets such as property, plant, and equipment have physical form. Intangible assets, in contrast, derive their value from the rights and privileges granted to the company using them. 2\. ***They are not financial instruments.*** Assets such as bank deposits, accounts receivable, and long-term investments in bonds and stocks also lack physical substance. However, financial instruments derive their value from the right (claim) to receive cash or cash equivalents in the future. Financial instruments are not classified as intangibles. **TYPES OF INTANGIBLE ASSETS** As indicated, the accounting for intangible assets depends on whether the intangible has a limited or an indefinite life. There are many different types of intangibles, often classified into the following six major categories. 1\. Marketing-related intangible assets. 2\. Customer-related intangible assets. 3\. Artistic-related intangible assets. 4\. Contract-related intangible assets. 5\. Technology-related intangible assets. 6\. Goodwill. - **Marketing-Related Intangible Assets** Companies primarily use **marketing-related intangible assets** in the marketing or promotion of products or services. Examples are trademarks or trade names, newspaper mastheads, Internet domain names, and noncompetition agreements. A **trademark** or **trade name** is a word, phrase, or symbol that distinguishes or identifies a particular company or product. Trade names like google, Pepsi-Cola, create immediate product identification in our minds, thereby enhancing marketability. Under common law, the right to use a trademark or trade name, whether registered or not, rests exclusively with the original user as long as the original user continues to use it. Registration with the U.S. Patent and Trademark Office provides legal protection for an **indefinite number of renewals for periods of 10 years each**. - **Customer-Related Intangible Assets** **Customer-related intangible assets** result from interactions with outside parties. Examples include customer lists, order or production backlogs, and contractual and non- contractual customer relationships. To illustrate, assume that Green Market Inc. acquires the customer list of a large newspaper for \$6,000,000 on January 1, 2012. This customer database includes name, contact information, order history, and demographic information. Green Market expects to benefit from the information evenly over a three-year period. In this case, the customer list is a limited-life intangible that Green Market should amortize on a straight-line basis. Green Market records the purchase of the customer list and the amortization of the customer list at the end of each year as follows. **January 1, 2012** Customer List 6,000,000 Cash 6,000,000 (To record purchase of customer list) **December 31, 2012, 2013, 2014** Amortization Expense 2,000,000 Customer List (or Accumulated Customer List Amortization) 2,000,000 (To record amortization expense) - **Artistic-Related Intangible Assets** **Artistic-related intangible assets** involve ownership rights to plays, literary works, musical works, pictures, photographs, and video and audiovisual material. Copyrights protect these ownership rights. A **copyright** is a federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations and expressions. A copyright is granted for the **life of the creator plus 70 years**. It gives the owner or heirs the exclusive right to reproduce and sell an artistic or published work. Copyrights are not renewable. - **Contract-Related Intangible Assets** **Contract-related intangible assets** represent the value of rights that arise from contractual arrangements. Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts. A **franchise** is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area. E.g A **Toyota** dealer, a **McDonald**'s restaurant, coca cola. - **Technology-Related Intangible Assets** **Technology-related intangible assets** relate to innovations or technological advances. Examples are patented technology and trade secrets granted by the U.S. Patent and Trademark Office. A **patent** gives the holder exclusive right to use, manufacture, and sell a product or process **for a period of 20 years** without interference or infringement by others. The two principal kinds of patents are **product patents**, which cover actual physical products, and **process patents**, which govern the process of making products. - **Goodwill** Although companies may capitalize certain costs incurred in developing specifically identifiable assets such as patents and copyrights, the amounts capitalized are generally insignificant. But companies do record material amounts of intangible assets when purchasing intangible assets, particularly in situations involving a business combination (the purchase of another business). To illustrate, assume that Portofino Company decides to purchase Aquinas Company. In this situation, Portofino measures the assets acquired and the liabilities assumed at fair value. In measuring these assets and liabilities, Portofino must identify all the assets and liabilities of Aquinas.