Discuss the treatment of expenditures as assets versus immediate expenses

Answer 1

TREATMENT OF EXPENDITURES AS ASSETS VERSUS AS IMMEDIATE EXPENSES

An expenditure qualifies as an asset if it (1) meets the definition of an asset, and (2) satisfies the criteria for asset recognition. These requirements are similar in U.S. GAAP and IFRS. FASB Statement of Financial Accounting Concepts No. 61 states that an asset has three essential characteristics:

1 . It embodies a probable future benefit.

2 . A particular entity can obtain the benefit and control others' access to it.

3 . The transaction or other event giving rise to the entity's right to, or control of, the benefit has already occurred.

FASB Statement of Financial Accounting Concepts No. 52 imposes an additional recognition criterion: the item must have a relevant attribute that a firm can measure with sufficient reliability. That relevant attribute is the fair value of the asset at the time of initial recognition.

Thus, firms treat expenditures as assets when they

1 . Have acquired rights to the future use of a resource as a result of a past transaction or
event.
2 . Can reliably measure the cost of the expected benefits at the time of initial recognition.

The exchange of cash for a resource with future service potential typically satisfies the first criterion. Satisfying the second criterion is more difficult because of the extended time that must elapse before expected benefits materialize. Satisfying the second criterion is more challenging for intangibles than for tangibles because of the difficulty of observing the realization of benefits. Expenditures that do not meet the criteria for an asset are expenses in the period incurred.

The accounting treatment of expenditures on resources with potential long-term benefits can be generalized as follows:

1 . Firms recognize expenditures to acquire or self-construct tangible assets as assets because the physical nature of tangible assets provides evidence of probable future benefits. The cost to acquire the tangible asset is the best evidence of the fair value at the time of the acquisition.

2 . Firms treat expenditures to develop intangibles internally as expenses when incurred because of the absence of an external market validation of the existence of an asset and its fair value. Exceptions occur for software development costs incurred after the point of technological feasibility under U.S. GAAP and for development costs generally after the point of technological feasibility under IFRS.

3 . Firms recognize expenditures to acquire intangibles externally from third parties as assets if the intangibles are either separable or arise from contractual or other legal rights. The
market transaction validates the existence of an intangible asset, whether completed or in process, and its fair value.

4 . In a business combination, the excess of the purchase price over the fair value of the identifiable net tangible and intangible assets is goodwill, an asset.

The accounting for expenditures with potential long-term benefits has been, and continues to be, controversial. Inconsistencies between the treatment of tangibles and intangibles and between costs incurred internally and externally permeate U.S. GAAP and IFRS. The user of the financial statements should recognize such inconsistencies when comparing a manufacturing firm with significant tangible assets and a technology or service firm with significant unrecognized intangibles, or when comparing a firm that develops brand names and other intangibles internally and one that acquires such intangibles from other firms.