Amortization Example note 18

NOTE 18 - AMORTIZATION OF INITIAL DEVELOPMENT COSTS

Initial Development Costs refer to the costs that must be incurred to complete the development of the Company's initial product (from January- April 200W). The Development Costs are presented below.

DEVELOPMENT ITEM
COST
Office Supplies Expense $ 500
Office Rent Expense $ 4,000
Phone/Fax Expense $ 700
Professional Services $ 2,200
Resource Materials $ 800
Internet Subscriptions $ 750
Management Salary $ 9,600
Product Development Salary $11,520
Information Technologist Salary $ 4,800
Mandatory Employer Costs (11%) $ 2,851
Casual Labor $ 1,200
Program/Software Writing $ 7,651
Miscellaneous Expenses $ 1,200

Total Development Costs * $47,772
* Total Development Costs do not include purchases of computer equipment ($7,602), nor office furniture purchases of $1,412

 

Below illustrates when the development costs are expected to occur (Cash Outflows). In addition, the Cash Inflows represent how J&B plans to pay for the development costs and future initiatives.

 
JAN.
FEB.
MARCH
APRIL
TOTAL
CASH INFLOWS:
Cash from Shareholders $20,000 $20,000 $20,000 $40,000 $100,000
Cash from Bank Loan $20,000 $ 0 $ 0 $ 0 $ 20,000

TOTAL CASH INFLOWS $40,000 $20,000 $20,000 $40,000 $120,000

CASH OUTFLOWS:


Office Supplies Expenses $ 500 $ 0 $ 0 $ 0 $ 500
Office Rent Expenses $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 4,000
Phone/Fax Expenses $ 175 $ 175 $ 175 $ 175 $ 700
Professional Services $ 550 $ 550 $ 550 $ 550 $ 2,200
Resource Materials $ 400 $ 400 $ 0 $ 0 $ 800
Internet Subscriptions $ 500 $ 0 $ 250 $ 0 $ 750
Management Salary $ 2,400 $ 2,400 $ 2,400 $ 2,400 $ 9,600
Product Development. Salary $ 2,880 $ 2,880 $ 2,880 $ 2,880 $11,520
Information Technologist $ 0 $ 0 $ 2,400 $ 2,400 $ 4,800
Employer Costs $ 581 $ 581 $ 845 $ 845 $ 2,851
Casual Labor $ 0 $ 600 $ 600 $ 0 $ 1,200
Program/Software Writing $ 0 $ 0 $ 3,825 $ 3,825 $ 7,651
Computer & Accessories $ 7,602 $ 0 $ 0 $ 0 $ 7,602
Office Furniture $ 1,412 $ 0 $ 0 $ 0 $ 1,412
Miscellaneous Purchases $ 300 $ 300 $ 300 $ 300 $ 1,200

TOTAL CASH OUTFLOWS * $18,300 $8,886 $15,225 $14,375 $56,786

Net Cash Flow (Deficiency) $21,700 $11,114 $ 4,775 $25,625

Plus Beginning Cash Balance $ 100 $21,800 $32,914 $37,689

ENDING CASH BALANCE $21,800 $32,914 $37,689 $63,314

* Total Cash Outflows of $56,786 is made up of the Development Costs ($47,772) and purchases of computer equipment and office furniture ($7,602 and $1,412 respectively).

 

J&B has decided to amortize the development costs ($47,772), equally over the useful life of the product. That is, over a three year period. As a result, the forecasted income statement shows a $15,924 amortization expense in year one, two and three. (Please Note: generally a company would expense these costs and expenses as they are incurred; that is, they would not be amortized)

YEAR 1 YEAR 2 YEAR 3

Amortization of Initial Development Costs $15,924 $15,924 $15,924

 

On the Company's forecasted balance sheet, an account called Net Intangible - Initial R&D can be viewed. This account uses amortization expenses to estimate the current market value of the Initial R&D . Below provides the calculation used in determining the Net Intangible (initial R&D) account balances;

YEAR 1 YEAR 2 YEAR 3

Initial Research & Development $47,772 $47,772 $47,772
Accumulated Amortization of initial R&D $15,924 $31,848 $47,772
Net Realizable Value - Initial R&D $31,848 $15,924 $ 0

 

As you can see, the asset is completely amortized at the end of year three; thus having no economic value.

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