 Hello and welcome to this session. This is Professor Farhad and this session we would look at intangibles and asset turnover. These topics are covered in a financial introductory accounting course as well as the CPA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, finance and tax lectures. Please, like my lectures, share them, put them in playlists. If they benefit you, it means they might benefit other people. So share the wealth, especially these days with the coronavirus out there. Also connect with me on Instagram. On my website, you will find additional resources, especially if you want to supplement your accounting education and CPA preparation. I suggest you check it out. So let's start by talking about intangibles. What are intangibles? Intangible are assets. Notice, obviously, intangible assets. So how do we define intangibles? Well, intangibles are noncurrent assets. Noncurrent, it means they last more than one period, more than one year. We're going to say the period is one year. What's special about intangibles is they lack physical substance. You cannot see them. You cannot touch them versus plant assets. And we talked about plant assets like vehicles, office building, warehouse, trucks, so on and so forth. Just like plant asset, they are usually acquired for operational purposes. So unless you are buying and selling patent, that's your job or buying and selling intangibles. That's what you do for a living. Generally speaking, when you obtain an intangible is for the purpose of operating your business. And what they do is they provide you with an exclusive right or privilege to conduct your business. So they give you an advantage in one way or another, maybe a secret formula, the right to operate in certain geographical area. The useful life of an intangible is often difficult to determine. But generally speaking, if you buy it, if there's a contract, you can follow the contract. But sometime, you don't know the life of the intangible. There are called unlimited life intangibles. And we'll talk about their useful life when we talk about the concept of amortization. When we acquire an intangible, the first thing we have to do is to record the intangible on the box. Generally speaking, we record it at cost. The cost includes the purchase price, legal fees and filing fees. Now here we are assuming we purchase the intangible. Sometime the intangibles are created internally. If they are created internally, we only have to capitalize the legal fees and the filing fees. And we'll talk about that in a moment. The best way to talk about intangibles is to look at actual intangibles, actual examples of intangibles. We will start with patents. What is a patent? Well, the patent is an exclusive right granted to the owner to manufacture or sell a patented item or use the process for 20 years. Let's be a little bit more specific. When you think of patent, think of pharmaceutical companies like Sanofi, Glaxox, Smith Klein, Merck, Johnson & Johnson, Pfizer and especially these days, for example, Sanofi and Rocher, at least those two companies are looking to manufacture a vaccine for the coronavirus. Now they need to do a lot of research and development and very fast to find that vaccine. What's going to happen once they do find it, the government will give them a patent, an exclusive right to produce it for 20 years. So this is what the purpose is. The purpose is to give you the right to recoup your money. Now if you create this vaccine internally, which most likely they will create it internally, all what they can capitalize is the legal and the filing fees. So unless you purchase it, if you purchase it, you will debit a patent account for the cost. So a patent, you can buy it or you can create it internally. If you create it internally, only capitalize. It means you treat as an asset only the filing, filing the paperwork, you know, the filing fees and the legal fees. Otherwise, the research and development cost, sorry, which we'll talk about at the end of this session is expense. It's an expense cost. Also what could happen when you have a patent, you can be challenged. Basically somebody might sue you, said, well, you infringe on my patent. Therefore, you need to discontinue your patent or you need to give me money or something of that effect. Now you have to defend yourself. If you successfully defend your patent, you will capitalize the defense. It means any money you spend, it's treated as an asset. If you were unsuccessful, any money you spend, it's treated as an expense and you are in big trouble too because now you have to worry about impairment, which we don't have to talk about here. But those are the rules. So let's look at a journal entry to see how this all fits together. Let's assume you purchase a patent for 25,000 with a useful life of 10 years. What you do is you debit the patent and you credit cash, assuming we paid cash. Now, just like with plant asset, remember when we have a plant asset, what do we do with plant asset? We depreciate. That's what we do with plant asset. Also, we talked about natural resources. When we acquire natural resources, what do we do with those? We deplete them. Just like with those two, it means we take the cost and we expense the cost. We expense the cost. In intangible, we call it amortize. We amortization. We're going to amortize this 25,000 over 10 years, amortizing $25,000 a year. So this is just very similar to depreciation, not similar. It's the same concept except we call it something else. Now in some textbook, they will credit the patent itself. In some textbook, they credit accumulated amortization. They're both acceptable. Another example of intangibles are copyrights, which is the exclusive right to publish and sell musical or artistic work. It gives you the life of the creator plus 70 years. The cost if you buy them is amortized over their useful life. Franchises and licenses, those are also intangibles. For example, if you want to operate a McDonald, you have to pay the parent company of McDonald a fee, for example, $100,000 or $200,000 or whatever the fee is. Well, that's also an intangible. It's the right to write a company, grant to an entity to sell a product. Sometimes the government might give you the right or service for under specified condition or under specified condition. The cost is amortized over the useful life of the franchise. So if McDonald gave you the right to operate for seven years and you paid $100,000, you split the $100,000 over seven years, it means you have a limited life for that intangible. Some intangibles will have unlimited life. Now, if the intangible has an unlimited life, it means once you buy it, you can use it forever. No amortization. The same concept as land. You remember we said land will have unlimited life. Therefore, we don't depreciate land. The same thing with the unlimited life intangibles. Trademark and trade names, think of Coca-Cola sign or the Apple sign, their symbols, name, phrase, or jingle, identify with a company or a product. They could be purchased or they could be created. If they are purchased, well, the cost plus any necessary cost to acquire it, if it's created, you only can capitalize the filing fee. And those intangibles are renewed indefinitely. It means they have unlimited life. Think about it. No one's going to let their trademark or trade name expire. Another intangible is called Goodwill. And when is Goodwill created? It's created when one company buys another company for a price and access of the net asset, of the fair value of the net asset. What is net asset? When you buy a company, you take a look at their assets, then you subtract their liabilities, and everything is done at fair value. So you look, fair value means how much it's worth today, not historical cost. And the difference between assets and liabilities is net assets. Once again, this is net asset fair value, net asset fair value. So you'll find out how much are they worth, net asset fair value. Then you pay a price. If you pay over the net asset fair value, you have a Goodwill. Let me give you an example. I'm not sure if you're aware that Microsoft purchased LinkedIn. So let's assume, for example, Microsoft paid $10 million for LinkedIn. They paid way more than 10 million for the sake of illustration. Let's assume at the time of the purchasing, then net asset, net asset identifiable fair value is eight. So they looked at LinkedIn assets, they look at the LinkedIn liabilities, they value everything at fair value, and they identify all the assets. And this means something that you don't have to worry about now on this course. But basically they looked at older assets, the one that's on the balance sheet and the one that are not on the balance sheet, everything that they can identify. And they find out the net asset is worth 8 million, but they paid 10 million. So the question is, why would you pay more than what the net asset is worth? Well, you pay 2 million more. Now why did you pay 2 million more? It could be the reputation of the company. It could be the relationship with the government. Certain things that you cannot identify. Sometimes it's the ego of the purchasing company. They want to make sure they want to get into that business. Therefore, they pay extra. Whatever they pay extra over that amount is called Goodwill. Now in this example, the Goodwill is 2 million. And that's all we have to know for Goodwill as far as this course. Now if you take intermediate accounting or advanced accounting, and I do have both of these courses on my YouTube channel, then you'll have to learn a little bit more about Goodwill. So it's much more complicated, but that's all you have to know. Just also know that Goodwill will have unlimited life. It's useful to know. It's unlimited life. It means it's not amortized. More intangibles. Right of use assets, which is a lease. Think about when you lease a car. You have a lessor, the car dealership, and the lessee, the person that's leased in it. So the owner is the lessor, leases the car to the lessee, or let's assume a building. They lease it the right to use. The right to use that building is an intangible asset because you can use it. It gives you the right privilege. Now what happened is when you buy this asset, I'm sorry, when you lease this asset, let's assume it's a building, you might have leasehold improvement. Let's assume you lease a warehouse or a store. Then you might put shelves on these stores. Those shelves are leasehold improvement. And notice the toilet papers. Again, it's everything now coronavirus related. So I know who knows who's going to grab this toilet paper bag next. But the point is you put those shelves. Those shelves are considered lease improvement because they are part of the building, but really once you leave, it's going to go away. So those lease improvements, since they improve the property, you spend some money, but they're going to go away. You cannot take them with you. You can also consider them as intangibles. When it comes to intangibles, we need to talk about research and development, but they are not intangibles. Research and development are expenditure to discover new product, new process, or knowledge, new product, new process, or knowledge. So research and development could lead to patents, copyrights, and innovation, but they are not by themselves intangible. So how do we treat research and development? Easy. We expense them. We expense them. And I put expense in capital to kind of remind you, we expense them. And why do we expense them? Because there's no future benefit when you are doing research and development. You don't know. You have no clue what's the end product might look like. You might spend millions or even billions of dollars, then throw all that money away because it's not useful. Therefore, what gaps has, if you are conducting research and development, you expense it. Now there are more specific rules, again, beyond the scope of the scores, but know that research and development are expense. Again, they're not intangible assets. So R&D, when I say R&D, it's research and development. Sometimes you would see it as R&D. That's what research and development is. The last thing we're going to cover in this session is the asset turnover. Asset turnover is net sales divided by average total assets. At this ratio, it's provided information about the company efficiencies in using its asset. Let's assume we have 5,000 in total assets and 10,000 in net sales. So net sales is 10,000. Total assets is 5,000. We will get an answer of 2. What does 2 means? It means for every $1 in assets that you have, on average, it's producing $2 in sales. That's what it means. It's because you have 5,000 in assets, but you produce, you generate a 10,000 of sales. Now, obviously, you want this number to be as high as possible. So they hired this number, the more efficient it means you are using your assets very efficiently. They hired this number. So the best way to look at this is to look at an actual example. So we'll look at Starbucks versus Jack in the Box. The asset turnover for Starbucks for this year is 1.56. For last year, it was 1.6. So the deteriorated in the prior year was 1.65. So now the Starbucks is deteriorating their asset turnover. It seems they're not being more efficient. They're not using their asset efficiently. That's all what it means. Over the years, it's deteriorating. Now, if we compare Starbucks to Jack in the Box, Starbucks is generating more sales per $1 in assets. They're generating $1.56 for every dollar invested in assets. Jack in the box, generating $1.21. So how can you improve this asset turnover? You can do one of two things or two things combined. You can increase your sales, reduce your assets, or do both at the same time. Generate more sales by having less assets. Think about it. Basically, producing sales, generating sales with less resources. If you can do that, your asset turnover will increase, and your efficiency is better. In the next session, we would look at the assets exchange. As always, I would like to remind you to like, subscribe, and share these videos. And if you are looking to supplement your accounting education, please visit my website. If you're looking to increase those CPA scores by 7 to 10 points, or if you're looking to supplement your education, it's the best way. It's a good way to do it. Study hard, and please stay safe. Good luck.