Chapter 1.21® - Amortization of Natural Resources e.g Mineral Deposits less Accumulated Amortization & Accounting for Goodwill (Intangible Capital Assets)
Natural resources are tangible capital assets that are physically consumed when used, and include assets such as oil and gas, gold & mineral deposits, timber, lumber, copper fields, etc. Because they are used up in production of other finished goods, they are known as ‘wasting assets.’ Natural resources are raw materials that are of no use until they are converted into finished products by mining, pumping or sawing. Thus, until they are fully converted, they are reported in the Balance sheet as non-current assets. Examples of asset titles used include Oil Reserves, Timberland or Mineral deposits.
Natural resources when acquired are recorded at initial purchase cost. This cost includes are reasonable expenses incurred to bring the raw materials together and prepare them for their intended use. The amount of amortization expense recorded on Natural resources depends on # of finished units extracted or depleted. This is very similar to the units-of-production amortization method we discussed above. As an example, consider Hargrave Mines Ltd purchases a mineral deposit of 450,000 tonnes of ore available to mine. The entire deposit is purchased for $2million with a salvage value of $300,000. What amortization expense is incurred on this Mineral deposit if 120,000 tonnes of Ore are mined in its 1st year?
The journal entry to record amortization expense is:
Below is a partial balance sheet showing the mineral deposits less the accumulated amortization of mineral deposits.
Accounting for Goodwill or Other Intangible Assets
Goodwill is a capital intangible asset and is the amount by which the price paid for a company exceeds the fair market value of the company’s net assets (assets – liabilities). Goodwill means the company has other useful ‘assets’ that cannot be measured on the Balance sheet, and they include superior senior management, skilled people, brand names such as Coca Cola, excellent business locations/head office location, superior quality products & services, good customer & public relations, etc.
Generally Accepted Accounting Principles (GAAP) does not permit companies to generate their own internal Goodwill. This is because then the Goodwill calculated could be biased, skewed to the higher side or over-stated and not truly objective of the value of the asset. Thus when a business is acquired, all its assets are Debited to their respective asset accounts and all Liabilities credited at fair market values. The purchase price of the business is debited to Cash, and the difference between total Assets – total Liabilities is debited to the Goodwill account. Here is an illustration to calculate Goodwill.
Consider Microsoft purchased Double Click Corp for a cash price of $11,000,000. Double Click has total assets that have a market value of $9,000,000 and liabilities of $3,000,000. Goodwill is calculated as below:
Microsoft’s entry to record the purchase of Double Click Corp is below.
Note: Goodwill is never amortized. Instead, goodwill is decreased only if its value has been decreased by management (this is known as impairment covered in another chapter). Impairment occurs when the net value of the Organization (purchase price) minus the net assets is less than the carrying value of Goodwill.