Assets recognition, measurement, and classification
Which of its resources should a firm recognize as assets? At what amount should the firm measure these assets? How should it classify them in the assets portion of the balance sheet? U.S. GAAP and IFRS establish the principles that firms must use to determine responses to those questions. Defining what resources firms should recognize as assets is one of the most important definitions among all of the principles established by U.S. GAAP and IFRS: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.2
Assets are resources that have the potential to provide a firm with future economic benefits:
the ability to generate future cash inflows (as with accounts receivable, inventories, and investment securities) or to reduce future cash outflows (as with prepayments) or to provide future service potential for operating activities (as with property, equipment, and intangibles). Therefore, asset recognition depends on managers’ expectations for future economic benefits. A firm can recognize as assets only those resources for which it:
Which of its resources should a firm recognize as assets? At what amount should the firm measure these assets? How should it classify them in the assets portion of the balance sheet? U.S. GAAP and IFRS establish the principles that firms must use to determine responses to those questions. Defining what resources firms should recognize as assets is one of the most important definitions among all of the principles established by U.S. GAAP and IFRS: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.2
Assets are resources that have the potential to provide a firm with future economic benefits:
the ability to generate future cash inflows (as with accounts receivable, inventories, and investment securities) or to reduce future cash outflows (as with prepayments) or to provide future service potential for operating activities (as with property, equipment, and intangibles). Therefore, asset recognition depends on managers’ expectations for future economic benefits. A firm can recognize as assets only those resources for which it:
- controls the rights to future economic benefits as a result of a past transaction or event.
- can predict and measure, or quantify, the future benefits with a reasonable degree of precision and reliability
If an expenditure does not meet both criteria, it cannot be capitalized as an asset and must be expensed. A firm should derecognize assets (that is, write off assets from the balance sheet) that it determines no longer represent future economic benefits (such as writing off uncollectible receivables or unsalable inventory). Resources that firms do not normally recognize as assets because they fail to meet one or both of the criteria include purchase orders received from customers; employment contracts with corporate officers and employees; and a quality reputation with employees, customers, or citizens of the community.
Most assets on the balance sheet are either monetary or nonmonetary.Monetary assets include cash and claims to future payments of cash (such as receivables). PepsiCo’s monetary assets include cash, accounts and notes receivable, and investments in debt and equity securities of other firms. Under U.S. GAAP and IFRS, balance sheets report monetary assets using a variety of measurement attributes intended to enhance the relevance and reliability of reported asset values. Some monetary assets such as cash are reported at current value. Others, such as accounts receivable, are reported at net realizable value (the amounts the firm expects to collect).
For other assets, such as notes receivable and loans with cash receipts that extend beyond one year, the firm reports the monetary asset at the present value of the future cash flows using a discount rate that reflects the underlying uncertainty of collecting the cash as assessed at the time the claim initially arose. Still other assets, such as debt and equity investment securities, are typically reported at fair value, which represents those cash amounts the firm could expect to realize if it sold the securities. more discussion of how accounting is a ‘‘mixed attribute’’ measurement system. Nonmonetary assets are tangible, such as inventories, buildings, and equipment, and intangible, including brand names, patents, trademarks, licenses, and goodwill. In contrast to monetary assets, nonmonetary assets do not represent claims to future cash flows. The amount of cash firms receive from using or selling nonmonetary assets depends on market conditions at the time of their use or sale. Under U.S. GAAP and IFRS, firms might report nonmonetary assets at the:
Most assets on the balance sheet are either monetary or nonmonetary.Monetary assets include cash and claims to future payments of cash (such as receivables). PepsiCo’s monetary assets include cash, accounts and notes receivable, and investments in debt and equity securities of other firms. Under U.S. GAAP and IFRS, balance sheets report monetary assets using a variety of measurement attributes intended to enhance the relevance and reliability of reported asset values. Some monetary assets such as cash are reported at current value. Others, such as accounts receivable, are reported at net realizable value (the amounts the firm expects to collect).
For other assets, such as notes receivable and loans with cash receipts that extend beyond one year, the firm reports the monetary asset at the present value of the future cash flows using a discount rate that reflects the underlying uncertainty of collecting the cash as assessed at the time the claim initially arose. Still other assets, such as debt and equity investment securities, are typically reported at fair value, which represents those cash amounts the firm could expect to realize if it sold the securities. more discussion of how accounting is a ‘‘mixed attribute’’ measurement system. Nonmonetary assets are tangible, such as inventories, buildings, and equipment, and intangible, including brand names, patents, trademarks, licenses, and goodwill. In contrast to monetary assets, nonmonetary assets do not represent claims to future cash flows. The amount of cash firms receive from using or selling nonmonetary assets depends on market conditions at the time of their use or sale. Under U.S. GAAP and IFRS, firms might report nonmonetary assets at the:
- amounts initially paid to acquire them (acquisition, or historical, cost) adjusted for the use of the asset over time (accumulated depreciation or amortization).
- amounts currently required to replace them (replacement cost).
- amounts for which firms could currently sell them (net realizable value).
- present values of the amounts firms expect to receive in the future from sellin or using the assets (present value of future cash flows).
Perhaps PepsiCo’s most valuable assets are its brand names (for example, Pepsi, Frito-Lay, and Quaker Oats), and brand names associated with specific products, like Mountain Dew and Doritos. PepsiCo and its subsidiaries created and developed these brand names through past expenditures on advertising, event sponsorships, product development, and quality control. Ascertaining the portion of these expenditures that creates reliably predictable future economic benefits and the portion that simply stimulates sales during the current period is too uncertain to justify recognizing an asset. The amounts that PepsiCo does report for amortizable intangible assets, goodwill, and othernonamortizable intangible assets result from PepsiCo’s purchases of other companies, where the transaction provides market evidence of the value of acquired intangibles. PepsiCo’s balance sheet reports $1,781 million of amortizable intangible assets and $14,744 million of nonamortizable intangibles, principally brand names. The remaining $16,971 million of intangible assets is goodwill, which represents the portion of the purchase price of other businesses that PepsiCo could not allocate to identifiable assets and liabilities. Every year, PepsiCo tests the value of all of its intangible assets for impairment, and if the evaluation indicates impairment, the intangible asset is written down to its estimated fair value.
The classification of assets in the balance sheet varies widely in published annual reports. The principal asset categories are as follows:
Current Assets.
Current assets include cash and other assets that a firm expects to collect, sell, or consume during the normal operating cycle of a business, usually one year. Cash; short-term investments; accounts and notes receivable; inventories; and prepayments for expenses such as rent, insurance, and advertising appear as current assets for PepsiCo.
Investments.
This category includes short-term and long-term investments in the debt and equity securities of other entities. If a firm makes such investments for shortterm purposes, it classifies them under current assets. Noncurrent assets include investments in noncontrolled affiliates. PepsiCo has recently acquired controlling interests in its affiliates (particularly its major bottlers), but still maintains investments in other noncontrolled affiliates. For these investments in noncontrolling interests, the company does not prepare consolidated financial statements; instead, it reports the investments on the balance sheet using the equity method
Property, Plant, and Equipment.
This category includes the tangible, long-lived assets that a firm uses in operations over a period of years. Note 4, ‘‘Property, Plant and Equipment and Intangible Assets,’’ to PepsiCo’s financial statements (Appendix A) indicates that property, plant, and equipment includes land and improvements, buildings and improvements, machinery and equipment, and construction in progress. It reports property, plant, and equipment at acquisition cost and then subtracts the accumulated depreciation recognized on these assets since acquisition.
Intangibles.
Intangibles.
Intangibles include the rights established by law or contract to the future use of property. Patents, trademarks, licenses, and franchises are intangible assets. The most troublesome asset recognition questions revolve around which rights satisfy the criteria for an asset. As Chapter 8 discusses in more depth, firms generally recognize the intangibles acquired in external market transactions as assets. For example, brand names and goodwill are included in PepsiCo’s balance sheet under the categories of amortizable and nonamortizable intangible assets, which are detailed in Note 4. However, firmsdo not recognize as assets intangibles developed internally by the firm (the Pepsi and Frito-Lay brand names, for example). The rationale for the different accounting treatment is that the value of intangibles acquired in external market transactions is more reliable than the value of internally developed intangibles.
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