Accounting capitalization research Essay

What is Involves when Amortizing Expenses

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Introduction

Seller financed mortgage (SFM) is an alternative route for buying and selling homes that avails advantages for both the sellers and the buyers.  In most cases sellers could find buyers fast if they are willing to finance the mortgage, as well as they could be in to make extra money on the transaction.  If there is any advantage the seller will forfeit, it is the receiving of a lump sum at the time of sales closing, but could sell the home faster. There is not much difference between SFM and traditional mortgage borrowing where there has to be a contract that will bound both sellers and buyers, enabling the seller to foreclose if there happens to be a payment default and could deduct all expenses from the home payment.  The only difference is the dealing would be between two entities, without involving a financial institution. This kind of arrangement could be set for over one year payment plan, where there will be an arrangement for the buyer to make a balloon payment at the end of the agreed upon period (Owners). 

One of the main reasons why SFMs are in existence is some homebuyers will find it difficult to meet the requirement of the so called traditional financing due to various reasons, such as bad credit ratings.  When that is the case, their only chance of buying a home could be through seller financing mortgage where they can deal with the sellers directly who would take risk to sell, by using their own discretion and could end up charging more interest.  What happens through the course of time is the buyers would be able to improve their credit rating and would qualify to obtain a balloon loan from traditional lenders after dealing for some time with seller-financed mortgages (Suite 101).  In a situation like this, those sellers who had carved such an arrangement in order to find buyers quickly will be willing to sell the note or the agreement for companies such as South Plains Mortgage LLC (SPM) that would make a reasonable offer for them.  However, the offer might not directly reflect what is taking place in the market place, although they could have the property whose note they are planning to buy appraised to know its exact market value.  Once they know the market value of the property a note holder is willing to sell, they would offer their price.  In a situation like this, they are serving two purposes.  The first one is the seller who arranged the financing could end up getting the lump sum for the value of the property, while the ownership is transferred to the new buyer who will agree to deal with the primary buyer.  The reason why companies such as SPM go into such a deal is they can make a profit on the difference, because they always offer a lower price for the note holder who might not mind to incur a reasonable loss to sell the property immediately.  After the deal goes through, SPM will start dealing with the mortgage holder who should direct the monthly payments to it.

One factor to take note of here is even if the length of the mortgage could be between 20-30 years, the buyer mostly goes into agreement to make a balloon payment between 5-12 years into the loan, by obtaining a loan from traditional lenders, because by then all the credit ratings problems could be ironed out.  This will be the period SPM will be dealing with the mortgage holders.

Assessment of the Financial Significance of the Problem

In all this, it is not difficult to see there is a substantial expense involved through the process of going out and finding the holders of SFMs from around the country, as there is no reliable database one can tap into to find out the available note holders who are willing to sell.  There is a need to go out, find the SFM holders, and make them familiar with what SPM is offering.  After they agree to sell the note to SPM there is also more expense incurred to close the transaction, as well as, for the continued follow up of the regular payment, since there is a need to deal with the mortgage holders on a monthly basis.  Based on that, some of the expenses incurred would require capitalizing and amortizing in five-years period since that is how SPM is doing it, whereas some of the incurred expenses need considering or expensing in the current fiscal year.

According to the accrual accounting system SPM should be using, it allows the company to amortize assets that are intangible over a given period so that it will be possible to reflect their real value in the books.  Intangible assets could vary in their nature. In the case of SPM, it is possible to consider the notes that it is buying from various holders as intangible assets since the amount of the properties it buys are only showing as account receivables in SPM’s books and there is no expense account showing what it is incurring to buy the properties.  C-RASS should treat them as Assets in its books as they are properties acquired, where the buyers or the mortgage holders will have to pay in full according to the agreement in order to posses the properties for good.  However, SPM is directly taking charge of the prosperities on behalf of C-RASS for the agreed upon time and would collect the monthly payments from the mortgage owners, whose number could be high since the company is dealing with many mortgage payers.  While in the process of collecting the monthly mortgages for the parent company, as well as, when its staff members go out and search for note holders who are willing to sell, it would incur various expenses.

Amortizing such expenses over a number of years is possible if incurred to pay for intangible assets.  For example, the amount paid to acquire the note could qualify as an expense amount that the company can amortize over the years the mortgage would be paid, because the various properties these two companies are buying are not finite for them.   It is also possible to do it every five years as a company policy.  Nevertheless, in this case that purchase expense goes only as a receivable in SPM accounts and it is the parent company that could amortize the cost it incurred to buy the notes, because the amount is not among the expenses of SPM is incurring in its fiscal year.  To close the deals SPM could issue the C-RASS check and the note purchasing expense would only show in C-RASS fiscal expense for the year incurred.

Defining the Problem at Hand

Because of the discussed nature of amortization where it deals only with intangible assets, in order to assign an expense account for amortization the nature of the expense should meet this criterion.  When looking at the list of the expenses SPM incurred for the involved fiscal year, there might be a few expense accounts that might qualify for amortization based on their intangible nature, as well as the utilizing of the expense could go into a definite or indefinite future.  Two such accounts are Title Company Name Purchase and Purchase Name that have a total of $21,000 between them and since they have an intangible nature it is possible to amortize them at the discretion of whoever is in charge over a five year period, even if the Name Purchased could have an infinite use after the amortization, but the possibility that it could be replaced could merit a probability.  Another expense account that the company can amortize is the expense incurred to lease the copier, assuming that the $2000 amount of the lease was a one-time payment that includes the maintenance and supply and if the assumption is the copier stays with the company for more than one year.  In a situation like this, it is not possible to consider the copier the property of the company since it will return it to the owner at the end of the lease and what the company owns is the lease that is intangible in nature.  However, if the $2000 amount is what the company incurs on a yearly basis to use the copier, it is not possible to amortize that since it is a fiscal expense.

It is also possible to look at other few expenses where it will be up to the company or the CPA to decide their nature.  Three such expenses are the cost incurred for the Trainer, In House Researcher, and the expense incurred to input data, because the benefit of whatever is involved here could accrue into the future. Because of that it is possible to avoid incurring the expense in one year, where amortizing it over five years is possible.  Again, there might not be a rule that states these three activities are investment in the future.  Nevertheless, it is possible to presume that the trained staff will enable the company generate revenue for many years to come, as well as the research done this year could still be used for several years to come in the future.  Furthermore, data inputted in the company’s system could be an intangible asset the company could use for many years to come, and such issues require the discretion of those who are in charge.  The regulation put out by FASB does not limit what items should fall in what it calls intangible category, which could mean that business owners and their CPAs could amortize certain expenses if they see good reasons for doing so.  At times, it might be possible to get some tax advantage in doing so, because instead of losing the expense accounts in a given year where the cash flow or the earning is low, spreading them over a few years could enable the company to show the expenses when there is a better cash flow and that would make the statements look better, especially for investors.

Consequently, because of the nature of the definition of amortization, which is different than depreciation that deals with tangible assets, it is possible to say that the majority of the expenses SPM had been incurring in the given fiscal year are fiscal expenses that should be shown as such, since that is what the accounting system requires.   However, if by any chance there is a possibility of considering amortization to be depreciation, there is an office equipment, a computer expense where amortizing it over five years is possible if that is considered being the lifetime of the computer.

Mitigating the Problem at Hand

The Financial Accounting Standards Board (FASB) had recognized that it is difficult to tell the useful life of some intangible assets and it requires the discretion of the companies involved when it comes to introducing a fair expense amortizing practice incurred while dealing with intangible asset (FASB Home Page).  This means FASB also recognizes that if the assets involved are tangible their depreciation should merit becoming a depreciation expense that is possible to amortized over fiver years.  However, intangible assets such as contractual or legal rights, where the involvement is owning mortgage notes in the case of SPM or if there had been expenses incurred for patents, licenses, trademarks, and the like, it is up to the CPA to pose questions such as, for how long the company will hold the mortgage notes before the mortgage owners paid up the debt?  Because that is a possibility, as there is such agreement in the contract, where at a given point the mortgage holders will be required to find a balloon loan to pay the outstanding loan.  In some situations, from the outset, the amount of time remaining in the contact could be a few years that will make the amortizing process of such notes easier.  In the case of SPM, there are other concerns about what will happen in case there is a payment default that will trigger the surfacing of other expenses, which could happen anytime in the years the note had been in the process of amortizing.  It is also possible the mortgage owners could close the deal ahead of time and if that happens it will interfere with the amortizing process that had been set on the estimated lifetime of the mortgage (All Business).

Therefore, even if amortizing intangible assets through an amortizing expense account would enable the company to reflect a much correct financial statements, it is difficult to be certain about the benefit of the amortization process since it could fall short or go beyond the contracted period.  Mortgage contracts do not have an infinite life for a company such as SPM, as the mortgage owners have a number of options at their disposal that they can use at any point that will change the status the mortgaged property has with SPM.  Consequently, whenever considering amortizing an expense account the particular expense has to deal with an intangible asset whose value is determined according to what is fair.  Other expenses such as those shown on the expense list for SPM all have current nature, where they are costs incurred to attain certain services and the amount paid is not for carried forward value in a form of contract to make the arrangement intangible.  A few good exceptions to mention might be expenses incurred for the Trainer that could be for the fiscal year.  The same applies for the in house researcher that is a salary expense incurred for the year and there is nothing accrued for the future unless the outcome of the research has intangible value that goes into the future as mentioned earlier.  The data input expense, which is a major expense of $94,000 is for the fiscal year it is a fiscal expense where there is nothing to accrue, hence there will not be any need to amortize it as an intangible contract.  The insurance expense covers the fiscal year and even if it is a legal agreement, unless there is a new premium payment for the next year it will cease to be effective.

The same applies for the advertising expense that looks substantial and if it is for five years, it will be possible to amortize it as an intangible contract, but the assumption here is the $60,000 was payment made for the fiscal year.   Accordingly, it is possible to analyze each expense account in the fiscal expense list for the fiscal year shown for SPM and arrive at a conclusion, where almost all of them have a fiscal nature and are costs incurred for services or consumable products such as gas, incurred for the fiscal year.

The only asset the office equipment, the expense incurred to lease it could be amortized since what SPM owns only the intangible lease contract and it will hand over the equipment at the end of the lease unless the arrangement is lease-to-own, and in that case the status of the product will change when the lease period is over.  If the office equipment has a value that will last several years, it is possible to depreciate the equipment, since it is a tangible asset.

Final Recommendation

The final recommendation is that given the nature of the business involvement SPM has, where it goes out and buys SFMs on behalf of R-CRASS and show the transaction as receivable in its books, while the notes bought will be shown as assets in R-CRASS accounts, the reality is both companies are not buying tangible assets.  What they are buying is intangible assets which are notes and the cost of the notes would be shown in the books of C-RASS that is entitled to amortize it over five years period if that is the company’s policy.  It is not only that, it exactly knows how many years are left in the mortgage contract and at what point the mortgage owner could pay up the debt to SPM by arranging a loan from a traditional lender and could amortize it over those years.  This is so because of the reasons discussed earlier why homebuyers prefer to deal with SFMs knowing that they could pay above the market price.  Most of them do not qualify for traditional loans because of their bad credit standing that requires ironing out over a given course of time.   This means both companies know that their chance of owning the property is very slim and it would happen only if they buy the property at the time of a foreclosure or they could foreclose the property if the mortgage owner fails to pay and simply transfer the title to their company, with an intent to resell the house in the future.  When that is the case, they have to pay the equity the mortgage owner has in the property.  The problem with such a situation might be they have to pay at market value that might eat into the profit they might make, simply because the homeowner could have the property appraised.

What is important for amortizing expense, however, is the nature of the expense has to have the component of an intangible asset that is finite and any expense incurred for such items could be amortized for the presumed lifetime of the items or according to a company policy for any number of years that are less than that life value of the item.  All other fiscal and current expenses require expensing them for the fiscal period they occurred so that they would reflect the exact cost the company incurred.

Conclusion
Amortization of expenses enables companies to show exactly what is happening in their business, while at the same time if there is anyone looking at their income statement, a $90,000 research expense will not dwindle their earnings for the number of years an expense is amortized.  If the $90,000 research expense is in this fiscal year income statement, it will bring down the total earning by an equivalent amount.  However, if the CPA is convinced that there will be some accrued advantage the company will attain for the research paid at this fiscal year the advantages gained could spread over five years, it is possible to divide the $90,000 for five years and arrive at $18,000 to deduct as research expense for this fiscal year and it is possible to boost the earning amount of the fiscal year by $72,000.   When investors look at the income statement they could tell the earning is much higher than it would have been if the $90,000 had been a deduction.

Nevertheless, the expense incurred would show on the cash flow account of the company since the amount has come out of this year’s cash flow.  But the next year cash flow account would show the exact amount generated for the particular year reflecting the expenses incurred for the year, but the earning account will be less by the $18,000 and it is possible some accountants could believe that might be better for those who could be looking at the statements.

The same applies in the case of depreciation, where it is possible to amortize tangible assets over their valuable lifetime and the effect they will have will be the same as amortizing intangible assets.  However, in most cases, tangible assets could be more in any given business making them frequent occurrences instead of the tangible assets that could be limited in most traditional companies.  Although their number could be high in high technology companies.  Intangible assets could be frequent occurrences for companies such as SPM that are buying SFM notes, because they will not own the properties whose notes they are buying unless they default.  It does not mean there will not be defaults, but when they occur companies such as SPM could benefit as they can buy the properties, turn them around and sell them for a higher profit, because they can wait for the right kind of buyers.

Whatever a business might be doing, amortizing mostly are delegated for intangibles that could be numerous, as the case of the research made on behalf of SPM could be useful for the company for many years to come.  If the company wants to amortize such expenses and if it believes it serves it a purpose or would reflect a better financial statement, as long as others accept it as a fair practice there are not set of rules that determine certain activities not to be considered as intangibles. Nevertheless, there are the obvious expenses companies incur that are intangible in their nature such as patent and copyright expenses that they can amortize because that is a common practice across the board.

REFERENCE

Suite 101, “What is Seller Financing”, Available at, http://home-mortgages.suite101.com/article.cfm/what_is_seller_financing, Retrieved on July 04, 2008.

FASB, “Summary of Statement 142”, Available at, www.fasb.org/st/summary/stsum142.shtml, Retrieved on July 04, 2008.

All Business, “Amortization of some Intangible Assets”, Available at, www.allbusiness.com/accounting-reporting/assets/285046-1.html, Retrieved on July 04, 2008.

Owners, “Financing a Home”, Available at, www.owners.com/Tools/Library/showarticle/287.aspx, Retrieved on July 04, 2008.

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