Financial Statement

A financial statement (or financial report) is a formal record of the financial activities of a business,
person, or other entity.
Relevant financial information is presented in a structured manner and in a form easy to understand. They
typically include basic financial statements, accompanied by a management discussion and analysis:
1. A balance sheet, also referred to as a statement of financial position, reports on a
company's assets,liabilities, and ownership equity at a given point in time.
2. An income statement, also known as a statement of comprehensive income, statement of
revenue & expense, P&L or profit and loss report, reports on a company's income, expenses,
and profits over a period of time. A profit and loss statement provides information on the
operation of the enterprise. These include sales and the various expenses incurred during the
stated period.
3. A statement of cash flows reports on a company's cash flow activities, particularly its
operating, investing andfinancing activities.
For large corporations, these statements may be complex and may include an extensive set of footnotes
to the financial statements and management discussion and analysis. The notes typically describe
each item on the balance sheet, income statement and cash flow statement in further detail. Notes to
financial statements are considered an integral part of the financial statements.

Purpose of financial statements by business entities

"The objective of financial statements is to provide information about the financial position, performance
and changes in financial position of an enterprise that is useful to a wide range of users in making
economic decisions."[2] Financial statements should be understandable, relevant, reliable and
comparable. Reported assets, liabilities, equity, income and expenses are directly related to an
organization's financial position.
Financial statements are intended to be understandable by readers who have "a reasonable knowledge
of business and economic activities and accounting and who are willing to study the information
diligently."[2] Financial statements may be used by users for different purposes:

Owners and managers require financial statements to make important business decisions that
affect its continued operations. Financial analysis is then performed on these statements to provide
management with a more detailed understanding of the figures. These statements are also used as
part of management's annual report to the stockholders.

Employees also need these reports in making collective bargaining agreements (CBA) with the
management, in the case of labor unions or for individuals in discussing their compensation,
promotion and rankings.

Prospective investors make use of financial statements to assess the viability of investing in a
business. Financial analyses are often used by investors and are prepared by professionals (financial
analysts), thus providing them with the basis for making investment decisions.

Financial institutions (banks and other lending companies) use them to decide whether to grant a
company with fresh working capital or extend debt securities(such as a long-term bank
loan or debentures) to finance expansion and other significant expenditures.

Consolidated financial statements

Consolidated financial statements are defined as "Financial statements of a group in which

the assets, liabilities, equity, income, expenses and cash
flows of
the
parent
(company)
and
its subsidiaries are presented as those of a single economic entity", according to International Accounting
Standard 27 "Consolidated and separate financial statements", and International Financial Reporting
Standard 10 "Consolidated financial statements".[3][4]
Government financial statements
The rules for the recording, measurement and presentation of government financial statements may be
different from those required for business and even for non-profit organizations. They may use either of
two accounting methods: accrual accounting, or cost accounting, or a combination of the two (OCBOA). A
complete set of chart of accounts is also used that is substantially different from the chart of a profitoriented business.
Personal financial statements
Personal financial statements may be required from persons applying for a personal loan or financial aid.
Typically, a personal financial statement consists of a single form for reporting personally held assets and
liabilities (debts), or personal sources of income and expenses, or both. The form to be filled out is
determined by the organization supplying the loan or aid.
Audit and legal implication
Although laws differ from country to country, an audit of the financial statements of a public company is
usually required for investment, financing, and tax purposes. These are usually performed by independent
accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an
unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit
opinion on the financial statements is usually included in the annual report.
There has been much legal debate over who an auditor is liable to. Since audit reports tend to be
addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them.
But this may not be the case as determined by common law precedent. In Canada, auditors are liable
only to investors using a prospectus to buy shares in the primary market. In the United Kingdom, they
have been held liable to potential investors when the auditor was aware of the potential investor and how
they would use the information in the financial statements. Nowadays auditors tend to include in their
report liability restricting language, discouraging anyone other than the addressees of their report from
relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.
Standards and regulations
Different countries have developed their own accounting principles over time, making international
comparisons of companies difficult. To ensure uniformity and comparability between financial statements
prepared by different companies, a set of guidelines and rules are used. Commonly referred to
as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the
preparation of financial statements, although many companies voluntarily discloseinformation beyond the
scope of such requirements.[5]
Recently there has been a push towards standardizing accounting rules made by the International
Accounting Standards Board ("IASB"). IASB develops International Financial Reporting Standards that
have been adopted by Australia, Canada and the European Union (for publicly quoted companies only),
are under consideration in South Africa and other countries. The United States Financial Accounting
Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.
Inclusion in annual reports
To entice new investors, public companies assemble their financial statements on fine paper with pleasing
graphics and photos in an annual report to shareholders, attempting to capture the excitement and culture
of the organization in a "marketing brochure" of sorts. Usually the company's chief executive will write a
letter to shareholders, describing management's performance and the company's financial highlights.

Notes to financial statements

Notes to financial statements (notes) are additional information added to the end of financial statements
that help explain specific items in the statements as well as provide a more comprehensive assessment
of a company's financial condition. Notes to financial statements can include information on debt, going
concern criteria,accounts, contingent liabilities or contextual information explaining the financial numbers
(e.g. to indicate a lawsuit).
The notes clarify individual statement line-items. For example, if a company lists a loss on a fixed
asset impairment line in their income statement, notes could corroborate the reason for the impairment by
describing how the asset became impaired. Notes are also used to explain the accounting methods used
to prepare the statements and they support valuations for how particular accounts have been computed.
In consolidated financial statements, all subsidiaries are listed as well as the amount of ownership
(controlling interest) that the parent company has in the subsidiaries. Any items within the financial
statements that are valuated by estimation are part of the notes if a substantial difference exists between
the amount of the estimate previously reported and the actual result. Full disclosure of the effects of the
differences between the estimate and actual results should be included.
Management discussion and analysis
Management discussion and analysis or MD&A is an integrated part of a company's annual financial
statements. The purpose of the MD&A is to provide a narrative explanation, through the eyes of
management, of how an entity has performed in the past, its financial condition, and its future prospects.
In so doing, the MD&A attempt to provide investors with complete, fair, and balanced information to help
them decide whether to invest or continue to invest in an entity.[6]
The section contains a description of the year gone by and some of the key factors that influenced the
business of the company in that year, as well as a fair and unbiased overview of the company's past,
present, and future.
MD&A typically describes the corporation's liquidity position, capital resources,[7] results of its operations,
underlying causes of material changes in financial statement items (such as asset impairment and
restructuring charges), events of unusual or infrequent nature (such as mergers and acquisitions or share
buybacks), positive and negative trends, effects of inflation, domestic and international market risks,[8] and
significant uncertainties.
Moving to electronic financial statements
Financial statements have been created on paper for hundreds of years. The growth of the Web has seen
more and more financial statements created in an electronic form which is exchangeable over the Web.
Common forms of electronic financial statements are PDF and HTML. These types of electronic financial
statements have their drawbacks in that it still takes a human to read the information in order to reuse the
information contained in a financial statement.
More recently a market driven global standard, XBRL (Extensible Business Reporting Language), which
can be used for creating financial statements in a structured and computer readable format, has become
more popular as a format for creating financial statements. Many regulators around the world such as
the U.S. Securities and Exchange Commission have mandated XBRL for the submission of financial
information.

Concept And Meaning Of Capital And Revenue

The main objective of accounting is to ascertain the true profit or loss and to reveal the financial position
of a business at the end of financial year.
To achieve the objectives, the business must take a clear distinction between
itscapital and revenue items. The distinction between capital and revenueitems is essential for their
correct treatment in the final accounts. Any incorrect treatment of those two items in the final accounts
adversely affects the operating results and financial position of the business.
Capital is the wealth invested by an investor for producing additional wealth. The original figure of wealth
is known as capital. Making of additional wealth with the investment of original capital is known

as revenue. Thus, capital is the source of the basis of revenue. In other words, capital is invested in the
business to earn revenue. For example, a trader has started a business with $ 1,00,000 and earns a profit
of $ 30,000 during the year. The original investment of the trader, i.e $ 1,00,000 is the capital and the
profit of $ 30,000 earned by the investor out of the investment is the revenue.
Capital items concerned with the payment for assets and receipt from the owners and outsiders. It is the
item of the balance sheet. It is of long-term nature and its benefit is long-lasting. In fact, capital items are
assets, liabilities and capital that determine the financial strength of the business.
Revenue item is concerned with the payment for producing or buying goods and receipt from sale of
goods and services. Those revenue incomes and expenditures are the items of trading and profit and loss
accounts. It is of short-term nature. Its benefit expires within the year. In fact, revenue items are incomes
and expenses, which determine the operating result (profit or loss) of the business.
The following capital and revenue concepts are relevant for accounting purpose
* Capital and revenue expenditures
* Capital and revenue receipts
* Capital and revenue losses
* Capital and revenue profits
* Capital and revenue reserves

Construction trading and profit loss account and balance sheet

The basic principles
All aspects of accounts are governed by these two principles.
a) First principle: Dual effect
Every transaction has two effects, not one, e.g. if a Cerial Marketing Board (C.M.B.) purchases grain it
has:
more
less cash.

stock

If the Dairiboard Company of Zimbabwe sells milk to a retailer, it has:

less
an amount owed by the customer if he does not pay immediately.

stock

b) Second principle: The accounting equation

The second principle stems from the first. Every transaction has two effects; these two are equal and
balance each other. Thus, at any given moment the net assets of a business are equal to the funds which
the owner or proprietor has invested in the business.
Net Assets = Proprietor's funds
is the ultimate accounting equation. An explanation of the terms is as follows;
Net assets are defined as a business's total assets less total liabilities.
An asset is defined as something owned by a business, available for use in the business.

 A liability is defined as the amount owed by the business, i.e. an obligation to pay money at a future
date.
Proprietor's funds represents the total amount which the business owes to its owner or proprietor. This
consists of:
Capital:
(amount
proprietor
plus
Profits: (funds
generated
or
Losses:
(funds
lost
Drawings: (amounts taken out of the business).

invested

in

by
by

the
the

the

business)
business)
minus
business) minus

Use of the accounting equation to find profit

We normally arrive at a business's profit or loss by means of a profit and loss account, but where
information about income and expenditure is lacking, the accounting equation can be a useful way of
finding profit. If:
Net assets = Proprietor's funds
then an increase in net assets = an increase in a proprietor's funds.
Considering what causes an increase in the proprietor's funds, we can say that INCREASE IN NET
ASSETS (from the beginning of a period to the end) is equal to:
New capital introduced + Profit - Drawings
during the same period. If three of these four amounts are known, the fourth can be calculated.
Manufacturing account
There are many firms, whether parastatal, sole trader, partnership or limited company, which manufacture
the final product to be sold from raw materials, e.g. a fertiliser company uses phosphates, ammonia and
so on to produce finished fertiliser pellets.
In this instance, a manufacturing account is required in order to arrive at the final cost of manufacture.
The manufacturing organisation will still need a trading and profit and loss account. The only major
difference is that, in the trading account, the entry for purchases is replaced by the cost of manufacture.
The cost of manufacture is calculated using a manufacturing account. Two important factors need to be
taken into account:
a) Different types of cost
The costs needed to prepare a manufacturing account can be broken down into two main categories
known as direct and indirect costs.
The main or direct costs are those of raw materials and labour which together are known as the prime
cost, although any expense which can be traced directly to any unit of production is also a direct cost. The
indirect costs are those associated with production but cannot be traced directly to a particular production
unit. These costs will include the general factory overheads such as light, heat and power, rent, rates,
insurance, depreciation of production machinery, etc. Certain labour costs, such as supervision by

foremen or factory managers, will also be indirect costs because they are not directly traceable to a
production unit but are absorbed as a general overhead.
b) The effect of stocks
One complication in constructing the manufacturing account is to remember that there may be opening
and closing stocks of raw materials and opening and closing values to attach to partly completed items
(work in progress).
Figure 2.1 Pro forma manufacturing account

YEAR ENDED 19X7

Opening stock of raw materials

Purchases

xx

Less closing
materials

stock

of

raw x

Cost of raw materials consumed

Direct manufacturing wages

Prime cost

xx

Factory overheads:

Rent and rates,

light, heat and power

Production cost of completed goods carried down to trading

account

xxx

Indirect wages

Depreciation of

Prod. machinery

xx

xx

Opening work in progress

xxx

Less closing work in progress

xxx

xxx

Now attempt exercise 2.1 and 2.2.

These adjustments can be seen in the pro forma manufacturing account which follows. (see figure 2.1.)
Exercise 2.1 A simple manufacturing account
The following are details of production costs of Aroma Pvt Ltd for the year ended 31 December 19X5.

1 January 19X5, stock of raw materials

1,300

31 December 19X5, stock of raw materials

1,800

Purchase of raw materials

10,000

Manufacturing (direct) wages

17,000

Royalties

600

Indirect wages

9,000

Rent of factory (excluding administration and selling and distribution departments)

2,080

Factory rates

640

General indirect expenses

680

Depreciation of work machinery

1,050

Prepare a manufacturing account for the year ended 31 December 19X5.

Trading account
The purpose of the trading account is to show the gross profit on the sale of goods. Gross profit is the
difference between the sale proceeds of goods and what those goods cost the seller to buy, or cost of
sales. The cost of sales for this purpose includes the amount which has been debited for them to the
purchases account plus the cost of getting them to the place of sale, which is usually the seller's
premises, i.e. the carriage inwards of those goods.
Preparing a trading account
The trading account is calculated by using a sequence of steps. It is essential that these steps are carried
out in the order indicated.
a) The first step is to transfer the balance on the sales account to the trading account:

Dr: Sales A/c

Cr: Trading A/c.

b) Next, debit the trading account with the cost of goods sold, starting with the opening stock:

Dr: Trading A/c

Cr: Stock A/c.

The opening stock is obviously the same as the closing stock of the previous period; in the first year of
trading, of course, there will be no opening stock.
c) The balance on the purchases account is then transferred to the trading account and added to the
opening stock figure:

Dr: Trading A/c

Cr: Purchases A/c.

d) Transfer any balance on the carriage inwards account to the trading account:

Dr: Trading A/c

Cr: Carriage Inwards A/c.

Add the carriage to the total arrived at in c) above. This gives the total cost of goods available for sale.
e) Deduct the value of closing stock from the cost of goods available for sale. Any item deducted from the
debit side of an account is, in effect, credited to the account. Deducting closing stock from the debit side
of the trading account is therefore crediting it to that account. The corresponding double entry will
therefore be to the debit of stock account:

Dr: Stock A/c

Cr: Trading A/c

(by deduction from the debit side).

We have now arrived at the cost of sales.
f) The balance on the trading account will be the difference between sales and cost of sales, i.e. gross
profit, which is carried down to the profit and loss account.
Point to Note:
The debit to stock account for closing stock is the value of the current asset of closing stock which will be
included in the balance sheet, as we shall see later. When the opening stock is credited to the stock
account in the next period, it will balance off the stock account.
Net sales (turnover) and net purchases: Goods which have been returned by customers are
represented by a debit balance on the sales return account. This must be transferred to the trading
account, otherwise the sales and gross profit in that account will both be overstated.
Following the same reasoning that allows us to deduct closing stock on the debit side of the trading
account, we may deduct the debit balance on the sales returns account from the sales credited in the

trading account. In this way, we show the net sales for the year. Net sales are known as turnover.
Similarly, we show the credit balance on the purchases returns account as a deduction from purchases in
the trading account to show the net cost of purchases. Goods which have been returned to suppliers must
not be included in the cost of sales.
Point to Note:
The order of items is most important. Sales returns must be deducted from sales; purchases returns must
be deducted from purchases; carriage inwards, if any, must be debited in the account before closing stock
is deducted. Figure 2.2 shows a pro forma trading account.
Figure 2.2 Pro forma trading account

Opening stock of finished goods

x Sales

Production cost of completed goods b/d (from manufacturing account)

Closing stock of finished goods

xx

Cost of sales

xx

Gross profit c/d

xx

xx

xxx

xxx

Gross profit B/d

xxx

N.B. A trading account is prepared very much like a manufacturing account but substituting the production
cost of completed goods for the usual purchasing figure (see exercise 2.3: Preparation of trading account)

The profit and loss account

Introduction: The remaining nominal accounts in the ledger represent non-trading income, gains and
profits of the business in the case of credit balances, e.g. rent, discount and interest receivable. Debit
balances represent expenses and losses of the business and are known as overheads, e.g. salaries and
wages, rent and rates payable, lighting, heating, cleaning and sundry office expenses. These must now
be transferred to the profit and loss account so that we can calculate the net profit of the business from all
its activities.
The profit and loss (income) statement presents a summary of the revenues and costs for an organisation
over a specific period of time. Such a statement is generally developed on a monthly, quarterly and yearly

basis. The profit and loss statement enables a marketer to examine overall and specific revenues and
costs over similar time periods and analyses the organisation's profitability. Monthly and quarterly
statements enable the firm to monitor progress towards goals and revise performance standards if
necessary.
When examining a profit and loss statement, it is important to recognise one difference between
manufacturers and retailers. For manufacturers the cost of goods sold involves the cost of manufacturing
products (raw materials, labour and overheads). For retailers, the cost of goods sold involves the cost of
merchandise purchased for resale (purchase price plus freight charges).
The balance sheet shows that the profit for an accounting period increases proprietor's funds. The trading
and profit and loss account shows, in detail, how that profit or loss has arisen. The profit and loss
statement consists of these major components: Gross sales - the total resources generated by the firm's products and services
Net sales - the revenues received by the firm after subtracting returns and discounts (such as trade,
quantity, cash)
Cost of goods sold - the cost of merchandise sold by the manufacturer or retailer.
Gross margin (profit) - the difference between sales and the cost of goods sold: consists of operating
expenses plus net profits
Operating expenses - the costs of running a business, including marketing
Net profit before taxes - the profit earned after all costs have been deducted. Figure 2.3 shows a pro
forma trading and profit and loss account.
Figure 2.3 Trading, profit and loss a/c for the year ended 31 Dec 19X0

Sales

Less: cost of goods sold stock, at a cost on 1 January ('opening stock')

Add: purchases of goods

Less: stock, at a cost on 31 Dec ('closing stock')

(x)

Gross profit

xx

Sundry income:

Discounts received

Commission received

Rent received

xx

Less: administration expenses

Rent

Rates

Lighting and heating

Telephone

Postage

Insurance

Stationery

Office salaries

Depreciation

Accounting and audit fees

Bank charges and interest

Doubtful debts

Distribution costs:

Delivery costs

Van running expenses

Advertising

Discount allowed

(x)

NET PROFIT

xxx

Explanations
It is essential that the difference between a trading and profit and loss account is clearly understood. The
following provides an explanation.
The trading account shows the gross profit generated by the business. This is done by comparing sales
to the costs which generated those sales. A retailer, for example, will purchase various items from various

suppliers, and add a profit margin. This will give him the selling price of the goods and this, minus the cost
of goods sold, will be the gross profit.
Cost of goods sold is calculated by:
Opening Stock + Opening Purchases (for year or period) - Closing Stock (cost of goods unsold at the
end of the same period).
This gives the cost of goods which were sold. Sales and cost of goods sold should relate to the same
number of units.
The profit and loss account shows items of income or expenditure which although earned or expended
by the business are incidental to it and not part of the actual manufacturing, buying or selling of goods.
In a complicated manufacturing industry and in service industries, different definitions of "goods", "net
profit" and "cost of sales" may exist.
Capital and revenue expenditure
Only revenue expenditure (e.g. heating bills) is charged to the profit and loss account; capital expenditure
(e.g. the purchase of a new plant) is not.
a) Revenue expenditure is expended on:
acquiring
assets
for
conversion
into
cash
(resale
goods)
manufacturing, selling and distribution of goods and day-to-day administration of the business
maintenance of fixed assets (e.g. repairs);
It is well to note that "cash" need not be paid or received to be accounted for. The amount of revenue
expenditure charged against the profits for the year or period is the amount incurred whether cash has or
has not been paid. This applies with sales as well. Even if cash for sales has not been received in the
year or period under review, sales will be included in the trading account. This is the "accruals" concept.
b) Capital expenditure is expended on:
start
up
of
the
acquisition
of
fixed
assets
(not
alterations or improvements of assets to improve their revenue earning capacity.

for

business
resale)

Capital expenditure is not charged to the profit and loss account as the benefits are spread over a
considerable period of time.
The balance sheet
Introduction: The balance sheet is a statement of the financial position of a business at a given date. It
is, therefore, only a "snapshot" in time. When comparing business performance, therefore, a number of
years and time periods may be more suitable. The balance sheet is the accounting equation but set out in
a vertical form in order to be more readily, understood i.e. the accounting equation.
Assets - Liabilities = Capital + Profit - Drawings
expressed in the form of a balance sheet is as follows:-

Assets

Less: liabilities

Net assets

Representing:

Capital

Profit for the year

Less: drawings

Proprietor's funds

This is a simplified form; in reality the assets and liabilities will be further sub-divided and analysed to give
more detailed information. Figure 2.4 shows a pro forma balance sheet.
Figure 2.4 Pro forma balance sheet
Balance sheet at 31 December 19X0

A)

Fixed assets

C
Cost

D
Depreciation

Net
(C-D)

value

B)

Freehold factory

Machinery

Motor vehicles

Current assets

Stocks and work in progress

Debtors and prepayments

Cash at bank

Cash in hand

C)

Current liabilities

Trade creditors

(x)

Accrued charges

(x)

(x)

D)

Net current assets

xx

E)

15% loan

(x)

xxx

F)

Representing:

Capital at 1 January

Profit for the year

G)

Less: drawings

(x)

Proprietor's fund

xxx

Explanations
As with trading and profit and loss accounts, the balance sheet has its own nomenclature. These are fixed
accounts, current accounts, current liabilities and funds:
A) Fixed assets: assets acquired for use within the business with a view to earning profits, but not for
resale. They are normally valued at cost less accumulated depreciation.
B) Current assets: assets acquired for conversion into cash in the ordinary course of business; they
should not be valued at a figure greater than their net realisable value.
C) Current liabilities: amounts owed by the business, payable within one year.
D) Net current assets: funds of the business available for day-to-day transactions. This can also be
called working capital.
E) Loans: funds provided for the business on a medium to long term basis by an individual or
organisation other than the proprietor.
F) This total is the total of the business's net assets.

G) This total is the total of proprietor's funds, i.e. the extent of his investment in the business. Within these
main headings the following items should be noted.
Fixed assets
Depreciation is an amount charged in the accounts to write off the cost of an asset over its useful life.
Current assets
Debtors are people who owe amounts to the business.
Prepayments are items paid before the balance sheet date but relating to a subsequent period.
Current liabilities
Trade creditors are those suppliers to whom the business owes money.
Accrued charges are amounts owed by the business, but not yet paid, for other expenses at the date of
the balance sheet.
Note:
Working capital. This is a term given to net current assets, or total current assets less total current
liabilities, e.g.

Current assets

7,600

Less current liabilities

1.800

Working capital

5,800

Working capital is important because it is the fund of ready resources that a business has in excess of the
amount required to pay its current liabilities as they fall due. Working capital is important; lack of it leads
to business failure.

Intangible Assets Accounting

Overview of Intangible Assets
An intangible asset is a non-physical asset that has a useful life of greater than one year. Examples of
intangible assets are trademarks, customer lists, motion pictures, franchise agreements, and computer
software.

More extensive examples of intangible assets are:

Artistic assets. This can include photos, videos, paintings, movies, and audio recordings.

Defensive assets. You may acquire an intangible asset so that others may not use it. Its useful life
is the period over which it is of value in being withheld from the competition.

Leasehold improvements. These are improvements to a leaseholding, where the landlord takes
ownership of the improvements. You amortize these improvements over the shorter of their useful lives or
the lease term.

Software developed for internal use. This is the cost of software developed for internal use, with
no plan to market it externally. You amortize these costs over the useful life of the asset.

Internally developed and not specifically identifiable. If there is not a specifically identifiable
intangible asset, then you should charge its cost to expense in the period incurred.

Goodwill. When an entity acquires another entity, goodwill is the difference between the purchase
price and the amount of the price not assigned to assets and liabilities acquired in the acquisition that are
specifically identified. Goodwill does not independently generate cash flows.
Initial Recognition of Intangible Assets
A business should initially recognize acquired intangibles at their fair values. You should initially recognize
the cost of software developed internally and leasehold improvements at their cost. The cost of all other
intangible assets developed internally should be charged to expense in the period incurred.
Amortization of Intangible Assets
If an intangible asset has a finite useful life, you should amortize it over that useful life. The amount to be
amortized is its recorded cost, less any residual value. However, intangible assets are usually not
considered to have any residual value, so the full amount of the asset is usually amortized. If there is any
pattern of economic benefits to be gained from the intangible asset, then you should adopt an
amortization method that approximates that pattern. If not, the customary approach is to amortize it using
the straight-line method.
If an intangible asset is subsequently impaired (see the following section), you will likely have to adjust the
amortization level to take into account the reduced carrying amount of the asset, and possibly a reduced
useful life. For example, if the carrying amount of an asset is reduced through impairment recognition
from $1,000,000 to $100,000 and its useful life is compressed from 5 years to two years, then the annual
rate of amortization would change from $200,000 per year to $50,000 per year.
If the useful life of the asset is instead indefinite, then you cannot amortize it. Instead, periodically
evaluate the asset to see if it now has a determinable useful life. If so, begin amortizing it over that period.
Alternatively, if the asset continues to have an indefinite useful life, periodically evaluate it to see if its
value has become impaired.
If the intangible asset is goodwill, then you cannot amortize it under any circumstances. Instead,
periodically evaluate it to see if its value has become impaired.

Impairment Testing for Intangible Assets

You should test for an impairment loss whenever circumstances indicate that an intangible assets
carrying amount may not be recoverable, or at least once a year. Examples of such instances are:

Significant decrease in the assets market price

Significant adverse change in the assets manner of use

Significant adverse change in legal factors or the business climate that could affect the assets

value

Excessive costs incurred to acquire or construct the asset

Historical and projected operating or cash flow losses associated with the asset

The asset is more than 50% likely to be sold or otherwise disposed of significantly before the end
of its previously estimated useful life
If there is an impairment of intangible assets, you must recognize an impairment loss. This will be a debit
to an impairment loss account and a credit to the intangible assets account.
The new carrying amount of the intangible asset is its former carrying amount, less the impairment loss.
This means that you should alter the amortization of that asset to factor in its now-reduced carrying
amount. It may also be necessary to adjust the remaining useful life of the asset, based on the
information obtained during the testing process.
You cannot reverse a previously-recognized impairment loss.