Depreciation on Franchises
For periodic revaluations, depreciation should be in accordance with the terms of the grant. If the grant is perpetual, no depreciation need be taken account of; if it is for a limited term, the cost of the franchise should be prorated over that term; if the grant is indeterminate, as defined above, not only should a very liberal depreciation policy be pursued with regard to the franchise but, in the case of the type of franchise granted by Massachusetts, a liberal provision for writing off all the assets should be made, unless in the execution of the law a policy of non-revocability of franchises has become fairly well fixed.
In contrast with the above, note the ruling of the Public Service Commission for the First District of the State of New York. “To this account—Franchises (Gas)—shall be charged ‘the amount (exclusive of any tax or annual charge) actually paid to the state or to a political subdivision thereof as the consideration for the grant of such franchise or right’ (Section 69 of the Public Service Commissions Law) as is necessary to the conduct of the corporation’s gas operations. If any such franchise is acquired by means of assignment, the charge to this account in respect thereof must not exceed the amount actually paid therefor by the corporation to its assignor, nor shall it exceed the amount specified in the statute above quoted. Any excess of the amount actually paid by the corporation over the amount specified in the statute shall be charged to the account ‘Other Intangible Gas Capital.’ If any such franchise has a life of not more than one year after the date when it is placed in service, it shall not be charged to this account but to the appropriate accounts in ‘Operating Expenses,’ and in ‘Prepayments’ if extending beyond the fiscal year.” To a depreciation account called “General Amortization” is to be charged, besides depreciation of tangible fixed capital, “such portion of the life of intangible fixed capital as has expired or been consumed during the month.”
Such careful regulations as to the content of intangible asset accounts are not always nor everywhere imposed at the present time. It is not putting the case too strongly to say that the reader of a balance sheet containing items about which practice is not standardized should always be on his guard to assure himself as to the content of such items in order to establish the legitimacy of their use and value.
Organization Expenses
Organization expenses are those costs necessarily incurred for the purpose of getting an enterprise under way, i.e., of putting it in readiness to do business and produce income. These expenses usually comprise such costs as state incorporation fees, attorney’s fees for drawing up the application and other papers, the cost of prospectuses, soliciting costs for stock subscriptions, fees paid promoters and organizers, cost of printing and issuing certificates of stock, cost of capital stock records, and similar items. These are necessary and unavoidable expenses without which the company cannot come into being. A company organized and ready to commence business is in a better position than one whose elements have not been brought into harmonious working. In the same way that the costs of installing machinery in position and ready for use are capitalized by being added to the value of the equipment, so may the organization expenses of a corporation be legitimately capitalized as being the measure of the amount of the greater value which these organized business elements have over the same elements unorganized. Capital has been brought together and set to work, management and plan of operation have been secured, and business is ready to begin.
Organization expenses are therefore, from the standpoint of classification, best treated as an intangible asset rather than as a deferred or prepaid expense. In strict theory the value of these costs will last as long as the corporate existence. In Italy where corporate life is limited to fifty years, it is prescribed that organization costs be prorated over the full life of the corporation. The best practice in this country requires a much more rapid writing off of these items; R. H. Montgomery[46] advocating writing them off as they occur or at most over the first two years’ operation. To one not cognizant of the many abuses which have crept in—and even frauds perpetrated—through this channel, the treatment advocated may seem harsh and severe. Perhaps no harm is done in pursuing a more liberal policy, if such expenses are carried under a proper title, if they are not used to inflate the value of the tangible assets, and if the caution stated above is observed as to the need for investigating the values of all intangible asset items. Certainly organization expense should never be used as a cloak for discount on stocks or other securities marketed.
Good-Will—Definition and Nature
The last of the intangible assets to be treated is good-will. Lord Justice Lindley, in an English case, says: “Good-will regarded as property has no meaning except in connection with some trade, business, or calling. In that connection I understand the word to include whatever adds value to a business by reason of situation, name and reputation, connection, introduction to old customers, and agreed absence from competition, or any of these things, and there may be others which do not occur to me.” The definition by George Lisle[47] is to the same general effect: “Good-will is the monetary value placed upon the connection and reputation of a mercantile or manufacturing concern, and discounts the value of the turnover of a business in consequence of the probabilities of the old customers continuing.” Good-will therefore includes every advantage connected with location, premises, reputation, personality, name, etc. That all these are elements of good-will cannot be gainsaid, but unless an earning power larger than that of a newly established competing concern goes along with these elements, no one would be willing to pay anything for the good-will of the old concern.
It sometimes happens in the case of a merger, that because of the dormant or latent good-will of the various units—or some of them—to be merged, a promoter may be willing to pay something more than the value of the tangible assets in order to acquire the various properties. Dormant or latent good-will signifies the excess earning power that would exist if it were not for poor management, an inharmonious working together of the various parts of the organization, and other similar handicaps which the new management will remove. It may be objected that until such handicaps have been removed there is no good-will; that any good-will brought into evidence through the removal of these handicaps is the good-will built up by the new concern and not the old. It cannot be denied, however, that all the other elements of good-will may have been acquired and built up by the old company and that without them the new concern would be unable to bring good-will into evidence simply by a change of management. It is true that the merger may be able to build up quickly a good-will of its own through the elimination of competition, and through the full utilization of all the advantages of the different units—such as access to supplies of raw material, favorable trade agreements of various sorts, and the like.