Capitalising Assets

Top Topic 10.05.2021 Balance Sheet Design Chapter

Every accounting and financial decision has an impact
Fixed assets
Potential in inventories
Impact on liabilities

Image: Haufe Online Editorial Office Fixed assets tie up capital for a long time. Postings during capitalization therefore have a long-term impact on the balance sheet. All decisions on the accounting treatment of fixed assets must always be made with a view to the financial ratios. Companies with large fixed assets such as manufacturing companies, rental companies or companies with large fleets of vehicles are particularly affected. Buy, rent, lease A decision with a major impact on the balance sheet is the choice of financing.

If an asset (VG) is purchased and own financial resources are used for this purpose, an asset swap occurs in the balance sheet. The balance sheet total is not increased, and the corresponding key figures are not changed. The liquidity shown in the balance sheet decreases.
In the case of external financing, the balance sheet is extended by the entries in fixed assets and liabilities. The ratios relating to the balance sheet total (e.g. equity ratio) deteriorate accordingly.

Leased assets do not appear in the balance sheet, leased assets usually only in the notes. On the other hand, running costs are usually higher. Rental commitments and leases are shown in the balance sheet for information purposes. This means that the values are known to the readers of the balance sheet, but leased or rented assets do not influence the most important key figures. Valuing The fixed assets to be capitalized must be assigned a value. The procedure is precisely described by law. However, especially when ancillary services from the supplier, such as training or commissioning, are to be provided or internal services are to be taken into account, there are certainly ways of influencing this. If all value components are handled correctly immediately, there is no need to reclassify at the end of the year. There is then no need for explanation. Example: Instruction or training? Whether the imparting of knowledge about a new machine to employees is instruction or general training is already determined in the purchase order, or at the latest in the supplier’s invoice. If the instruction has a real relation to the delivered machine, then the costs for it must be capitalized. Then it is not allowed to talk internally about training, further training or education. The costs are to be booked accordingly as instruction. Capitalize The value of fixed assets depends on the amount of depreciation already made. In turn, depreciation begins at the time of capitalization. This is specified in the law. And yet, in practice, it is certainly possible to influence the time of capitalization within certain limits.

Depreciation begins when the asset is functional and available. Delivery dates or an official commissioning can, if desired, be brought forward or postponed by a few days. This makes it possible to influence capitalization and thus the start of depreciation relative to a balance sheet date.
Large investment projects can often be divided into several small independent projects. Then it is also possible to capitalize the sub-projects. In this way, the depreciation start date for parts of the asset can be brought forward. For these possibilities of influence, early planning and control is necessary. Those who only try to exert influence at the end of the year will fail.

External fixed assets The relationship between customer and supplier is becoming increasingly close. For customer loyalty, the latter often provides machines, storage facilities or transport equipment to process the delivered products. If this equipment is not sold or donated to the customer, it remains in the company’s fixed assets. As a result, fixed assets increase and total assets grow. All the key figures geared to this change accordingly. For example, the equity ratio deteriorates if more fixed assets are reported than necessary. The reporting of external assets in the company’s own fixed assets ensures that the costs are distributed over the useful life through depreciation. Something similar can also be achieved by giving the asset to the customer as a gift or selling it at a symbolic price. The costs are incurred immediately. Customer loyalty must then be achieved through long-term supply contracts. Again, decisions must be made before the customer receives the asset. The basic specification of how to deal with such plants must be made consciously. Top TopicsDownloads Haufe trade magazines last updated on October 4, 2022 | Reading time approx. 4 minutes Although brands generate a significant proportion of the value added within a company, they may not be recognized in the balance sheet – if they are created by the company itself – and are often regarded as the “problem children” of accounting law. Only acquired brands can be capitalized. What rules must be observed in accounting under HGB and IFRS and where is the scope that can be exploited in accounting policy and what will reporting require in the future? “The eternal “problem children” of accounting law – public discussion on intangible assets” – under this title, the German Accounting Standards Committee e.V. (DRSC) invited to the discussion on May 4, 2022. Because reporting on intangible assets is more topical than ever, even without relevant changes to the legal framework. Today, intangible assets, and brands in particular, often represent a significant share of a company’s value creation. The share of brands in the value of a company is significant. Nevertheless, a company’s balance sheets often do not contain any corresponding assets or items. This is due to the strict prohibition on capitalizing self-created brands. It is true that the German Accounting Law Modernization Act (BilMoG) lifted the ban on capitalizing internally generated intangible assets in the German Commercial Code in 2009. However, this only applies to expenses for the development of a product or an internally used technology. In addition to internally generated print titles, publishing rights, customer lists and comparable intangible fixed assets, the HGB also continues to prohibit the recognition of internally generated brands. As a rule, they cannot be separated beyond doubt from the development of the company as a whole – the same applies under IFRS. Under tax law, there is still a strict prohibition on capitalizing all internally generated intangible assets. The positive flip side of the coin: all brand-related expenses for marketing, advertising and other brand-building measures can be booked directly as operating expenses and thus tax-reducing.

Permissibility of capitalizing a brand “
Determining the fair value “
Derivation of an appropriate useful life “
Recoverability of a recognized brand “
Requirements of sustainability reporting “
Conclusion “

Permissibility of capitalizing a trademark

According to HGB, IFRS and also tax law, the capitalization of a trademark is only permissible in the case of acquisition from third parties. If an individual trademark is acquired, this must be recognized in the financial statements of the acquirer. If, in the case of a share deal, the trademark is part of the acquired company, the purchase price must be allocated to the acquired net assets in a purchase price allocation (“PPA”) for the consolidated financial statements of the group of companies concerned following the acquisition. The hidden reserves to be disclosed and thus also the trademark are thus capitalized there at fair value. In the case of an asset deal, the same applies to the accounting treatment in the acquirer’s financial statements.

Determining the fair value

The decisive factor in accounting for an acquired trademark is therefore the reliable measurement of its fair value. The principles for measuring brands are set out in relevant standards. In practice, the surplus method and the license price analogy are most frequently used (see the article “Value-based brand management”).

Derivation of an appropriate useful life

If a specific useful life can be determined for the trademark, it is also decisive for determining the amortization period according to HGB and IFRS. This is often the case with product brands that have a limited lifespan, and corporate brands are also subject to a limited useful life. Various studies show that a so-called forgetting effect occurs quite quickly. Many once world-famous and now faded to almost forgotten brands such as Hoechst, NSU or Horten are proof of this. If the indefinite (i.e. infinite) useful life of a brand can only be achieved through maintenance expenses, e.g. through regular advertising, the brand – in contrast to IFRS – must be subject to mandatory amortization under HGB. According to GAS 24 “Intangible Assets in the Consolidated Financial Statements”, the amortization method must reflect the course in which the economic value of the intangible asset decreases for the company. If the course of consumption of value cannot be reliably determined, straight-line amortization is to be applied. In practice, the upper limit of the useful life for corporate brands is often based on the tax amortization period for goodwill of 15 years.

Recoverability of a recognized trademark

If a brand is assumed to have an indefinite useful life under IFRS, no scheduled amortization may be charged. Instead, an impairment test must be carried out annually or in the event of triggering events that give rise to a presumption of impairment. This involves comparing the carrying amount of the brand with the recoverable amount. This is the higher of the fair value less costs to sell on the basis of an arm’s length sale and the subjective, DCF-based value in use. If the recoverable amount is lower than the carrying amount, the asset must be written down to this value.

Sustainability reporting requirements

Intangible assets are also of great importance for sustainability reporting and will therefore be subject to reporting requirements above and beyond the intangible assets or values already recognized in the balance sheet. For example, with regard to employee concerns or relationships with various stakeholder groups. For this reason, the draft of the new CSRD also provides for mandatory disclosures on intangible assets that are of central importance to the company’s value creation and business model. This applies regardless of how they are accounted for. If property, plant and equipment are acquired, a distinction must be made between the acquisition stage (or production stage) and the date on which the acquisition or production is completed and the fixed assets can be capitalized. The decision on the acquisition or production stage is significant for the determination of acquisition or production costs, to which all incidental costs are to be allocated. For the transfer of fixed assets to the operational state, technical-economic characteristics must be present (completion) and legal requirements must be met (issuance of the certificate of operational state). This can lead to difficulties, as the legal regulations do not precisely regulate whether the assets become ready for operation when the certificate is issued or when the requirements for issuing this certificate are met. The time when the certificate is issued may differ seriously from the time when the requirements are fulfilled. The date of the certificate shall be determined at the discretion of the Company in accordance with the economic aspects of the acquisition. The legal transaction may not be concealed by a sham transaction.

Activation date

If the technical and economic conditions do not coincide with the legal situation, it is necessary to check whether the assets are ready for operation or not: a) If the issuance of an official certificate of operational readiness is required to put the assets into operational readiness, the assets are capitalized as of the date when the certificate of operational readiness became effective (in this case, the legal situation is decisive for the completion of the assets). As an example, we can mention aircraft or vehicles, which may be capitalized only upon their registration. b) If the certificate of operational condition is issued subject to verification and the fixed assets can be used even before the issuance of this certificate (since profits are realized from the use of the assets), the assets shall be capitalized as of the date from which they can be used for the intended purpose. c) If the certificate of operational readiness is issued prior to the completion of the assets, the assets shall be capitalized as of the date when they can be used for the intended purpose. If the certificate of operational condition is issued in several stages, it should be checked whether the completed stage corresponds to the circumstances under points a) or b). When assessing whether the conditions for issuing the certificate on the operational condition of assets are met, all events known at the time of preparation of the financial statements should be taken into account – internal information on the fulfillment of legal requirements, interim results of audit processes or official interim decisions, taking into account also events after the balance sheet date. If a building is constructed, the trial operation of which is ordered, this building can be capitalized with its completion before the end of the trial operation, if it is sufficiently certain that the utilization permit will be issued (similar buildings were also acquired in previous years, and these buildings met the legal requirements). If experience with similar buildings is not available, a decision on capitalization should be made only after the results of interim tests during trial operation and after any official interim reports. Property, plant and equipment should be capitalized as of the date when the main characteristics of facilities meet the requirements for placing the asset in operational condition, according to point a) or according to the form of the certificate of operational condition according to point b). By establishing operational processes, acquired assets can be used for profit realization according to legal regulations even before issuance of the certificate of operational condition, if such certificate is issued only for the subsidiary features of acquired assets. If a certificate of operational condition is not issued, and this certificate is intended only for the ancillary features of acquired assets, this is irrelevant for the capitalization of fixed assets. If the certificate of operational condition is issued in several stages, it is necessary to assess whether each stage corresponds to the facts according to point a) or point b). If it is later determined that the fixed assets were either incorrectly capitalized or not capitalized, the capitalization or non-capitalization must be corrected. In deciding whether or not there is an accounting error, the opinion of the Institute of Accountants I-29 shall be used. It is also possible to use a machine that is claimed from the supplier, where, for example, the handover protocol has not yet been signed and the machine is not legally owned by the customer. However, if the machine is used for the manufacture of products from which profits are realized, the economic aspects are more important than the legal situation. According to the accrual principle, allowances or write-downs must be made for omitted depreciation. In the above paragraphs, we have assessed the capitalization date under commercial law. However, we would like to point out that there are also tax aspects to be considered which do not necessarily coincide with the commercial law assessment (e.g. different capitalization dates) and which should be taken into account when deciding on the commencement of depreciation for tax purposes. Any uncertainties should be discussed with a tax advisor. The decision on the timing of capitalization is important because the financial statements must present a true and fair view of the financial position and results of operations. If fixed assets are capitalized at an incorrect time, their book values may be too high or too low, with the earnings situation being worsened or improved by the excessively low or high depreciation. For this reason, a depreciation schedule should be prepared, regulating the time of capitalization and also the particular forms of acquisition. Capitalising Assets.

Anna Hein

Capitalising Assets