invested in other companies. If the percentage holding of common stock
in the other company is large enough, the balance sheets of the two com-
panies are often combined or consolidated. The value of the common
shares of outside holders is then presented as minority stock of sub-
sidiaries on the liability side of the major firm’s balance sheet. If the
firm’s holding in another company is large enough to give it considerable
control in the other company’s management but the parent company
does not care for one reason or another to consolidate the statements,
the account will usually be headed “investment in nonconsolidated sub-
sidiaries.” A fairly common adjustment to the investment account is to
add the retained earnings of the subsidiary company to the acquisition
cost of the original securities. If this is done, the going market price and
the original cost of the investments should be indicated in a footnote to
the balance sheet.
Patents, franchises, and copyrights are classified among the intangible
assets. They are carried at a conservative development cost or at the pur-
chase cost, if they were bought from some other firm or individual. Since
patents, copyrights, and franchises have a limited legal life (17 years for
patents), they are written down in value, or amortized, year by year over
their legal lives, or sooner if they have lost their economic value. The pro-
portionate periodic charge is considered a proper expense deduction on the
profit and loss statement. If these assets do have true economic value, it is
reflected in a higher rate of earnings on the firm’s tangible assets compared
to the return of other companies.
A major item that sometimes appears among the intangible assets is
goodwill. It represents the capitalized value of some intangible economic
advantage the firm possesses over similar companies: perhaps a good name
built up over many years, a superior product, an advantageous geographi-
cal location, or an especially efficient management. The advantage, what-
ever it may be, should be reflected in the rate of earnings above the normal
return for this type of business; the conservatively capitalized value of this
extra flow of earnings represents goodwill. Accountants, however, are gen-
erally reluctant to recognize goodwill or put it on the books unless it is
purchased or sold in a bona fide, arm’s-length transaction. Such a transac-
tion occurs when a successor firm is justifiably capitalized at a higher figure
than the book value of the old company’s assets, or when a firm is sold as a
subsidiary to another company at a figure higher than its net asset value on
the books. Similarly, goodwill is recognized if a new partner entering a firm
is willing to invest more money for an equal partnership than the book
value of the shares of the other partners. Goodwill should be understood
for what it is and its justification tested in terms of present or potential
earning power of a going concern.
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