# Financial Accounting – Losses and Risks

Table of Contents

## Intangible assets

An intangible asset can have either a determinate or indeterminate valuable life. These two categories of intangible assets are treated differently during amortization. For instance, amortization needs to be carried out on an asset that has a predetermined useful life. This is achieved by calculating a regular amount to expense during their useful life. The useful life is similar to the duration of time the asset will contribute positive cash flow to the business. There are a number of factors that needs to be taken into account when calculating the useful life. In the case of the indefinite intangible assets, the assets do not have a foreseeable limit of their useful life. Thus, the asset will be held on the books of accounts of the business as long as they can generate cash flow. Therefore, it is difficult to ascertain the useful life of this type of an asset. This limits the ability to charge a regular amount, which represents the loss of value, in the income statement. Since this category of intangible assets is not amortized, they are tested for impairment on a yearly basis. Thus, losses are determined by comparing the running book balance of the asset with a reasonable value, probably the market value, to determine if there are losses.

Intangible assets that have been generated internally and those bought have dissimilar accounting treatment. For intangible assets that are bought, the price at which they are bought is recorded in the corresponding account. The costs that will be capitalized comprise of the purchase price and other related expenses. In case an intangible asset is received in exchange for other physical assets, then fair value of the intangible asset will be recorded in the books of account. On the other hand, the amounts that are spent on coming up with an intangible asset are left out when capitalizing the asset. Further, the amounts that directly relate to the assets are capitalized. An example is the legal fees. All the other expenses are debited in the income statement.

## Inventories

The lower-of-cost-or-market criterion is used to estimate the cost of inventory. This criterion ensures that costs do not exceed the benefits that will be derived from selling such inventories. Benefits are derived from inventories once they are sold. However, there are various factors that can lower the value of inventories. Examples of these factors are variations in the level of prices and loss of value over time. Therefore, this approach of valuing inventories facilitates the recognition of losses when the value of inventory decline rather than the period when they are sold. One major criticism in the use of lower-of-cost-or-market is that it cannot be used in some companies. Examples are companies that deal with precious metal, minerals, and agricultural products. The market values of such products are readily available. This implies that other products whose market prices are not readily available cannot be valued using this approach. Another limitation of this approach is that it requires the use of net realizable value. The process of computing this value is quite involving.

## Income statement

GAAP provides clear outlines that should be followed when reporting income. This set of standards outlines that accrual basis should be used when computing the profit for the year. When using accrual, income is reported after it has been made. In most cases, this usually occurs before the actual cash is received. Based on this criterion, cash is earned when customers have confirmed the receipt of goods. Further, expenses are reported in the period when they occur. In some case, actual payment occurs after the corresponding transactions have been recorded in the books of account. Under cash basis of accounting, the recording of transactions in the books of account and the actual movement of money occurs in the same period. Further, the books of accounts are adjusted with the payments made for various outlays once the cash account has been credited. Since these two methods of accounting are different, then the results that will be generated at the end of the period will also be different. The accrual basis gives a holistic view of profit for a given period because it lists the values of all revenues earned and expenses incurred during a given financial year. Thus, it gives a better view of the financial position of an entity than cash basis. Even though the cash basis of accounting reflects on the taxable income of an entity, it does not fairly present the income at the end of the period.

## Disclosure notes

The narrations at the end of the financial report are vital component of the result. The basic financial statements do not provide all the information that is required by the users. Thus, the notes give information on the assumptions, principles, and methods that are used by a company when preparing the financial statements that are free from material misstatement. Further, there are specific items such as accounting policies and related third party transactions that are always included in the notes of all companies. Thus, any information that can be used by users to make decisions is included in the notes. They enable users to know how particular accounting principles are applied when coming up with the financial statements. The disclosures also allow the users to evaluate the performance of various entities. Thus, it is important for all profit-making entities and non-profit making entities to make a disclosure. The notes to financial statements are vital when evaluating the financial standing and strength of a company. This is based on the fact that they are designed to suit the needs of a specific company. The notes give a full view of the values presented in the financial statements and their justification. This makes them vital when understanding the financial results.

## Interest costs

When using US GAAP, the interest expense is included in the cost of an asset. However, there are three items that need to be taken into account before carrying out capitalization. First, the assets that qualify are those that are constructed or manufactured for use in the company. This category also includes assets that are planned for sale or lease. Assets that are produced on a frequent basis are not capitalized. Secondly, interest expenses that are capitalized are the amounts spent on borrowing costs before the asset is completed. These costs relate to the acquisition period only. Thus, interest costs that are incurred after the asset is completed are ignored. Further, the rate of interest to be used should be similar to those that the company is currently being charged. The capitalization period will continue as long as expenses for the asset have been made, borrowing costs have been incurred, and the activities that are necessary to bring the assets to usable state are under way. Thus, it can only end after construction of the asset is extensively finished.

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BusinessEssay. "Financial Accounting - Losses and Risks." October 31, 2022. https://business-essay.com/financial-accounting-losses-and-risks/.