University:
Stanford University
Course:
ECON 202 | Microeconomics I
Academic year:

2023
Views:

269

Pages:

2
Author:

T. Elton

The Problem of Intangibles Before we turn to the measurement of assets, we must address the problems raised by the alternative treatments of intangibles in accounts. It is still possible to choose between capitalizing and expending certain intangibles, and even when SSAPs and SORPs lay down a definitive treatment for external reporting purposes, the decision maker is perfectly entitled to adopt whatever policy suits his purposes when it comes to the preparation of internal state-ments. However, writing off to his income statement expenditure which is expected to provide future benefits to the division will deflate profits and understate ROI and RI in the early years, and overstate ROI and RI once the steady state is reached if a roughly equal outlay is made each year, the steady state will be reached when the sum of the amortization of previous and current expenditure approximates to the annual outlay). We can illustrate this situation with the help of the following example. Example A division currently has profits of £25,000 on an investment base of £100,000; its cost of capital is 10 per cent. It begins to incur expenditure on intangibles of £5,000 per annum, and each outlay of £5,000 brings in a profit of £2,000 per annum for 4 years from the year following the expenditure. For convenience, the ROI calculation is based on the investment base at the end of the year under consideration: Variant (1) - Expensing the intangibles (write off to P & L) Variant (2) - Capitalizing the intangibles and amortizing the expenditure in equal instalments over 5 years If the annual outlay is expensed, (variant (1)), divisional profit, ROI and RI are artificially reduced in years 1-3, because of the absence or low level of associated inflows.