Financial Accounting I Unit 11 Review: Long-Term Assets

What Are Long-Term Assets?

• Long-term assets are resources a company owns and uses for more than one year to generate revenue
• Provide long-term economic benefits to the company and are not intended for immediate sale or consumption
• Typically have a useful life greater than one accounting period (usually one year)
• Recorded on the balance sheet under the non-current assets section
• Examples of long-term assets include property, plant, and equipment (PP&E), intangible assets (patents, trademarks), and long-term investments
• Require significant upfront investment and are expected to generate returns over an extended period
• Acquisition costs are capitalized and allocated over the asset's useful life through depreciation or amortization
• Play a crucial role in a company's operations and long-term strategic planning

Types of Long-Term Assets

• Property, Plant, and Equipment (PP&E)
  • Tangible assets used in business operations (buildings, machinery, vehicles)
  • Subject to depreciation over their useful lives
• Intangible Assets
  • Non-physical assets that provide long-term benefits (patents, trademarks, copyrights, goodwill)
  • Amortized over their useful lives or tested for impairment annually (goodwill)
• Long-Term Investments
  • Investments in securities or other companies held for more than one year (bonds, stocks, partnership interests)
  • Recorded at cost and adjusted for changes in fair value or equity method
• Natural Resources
  • Assets acquired for the extraction of valuable materials (oil reserves, mineral deposits, timber)
  • Depleted based on the units-of-production method
• Long-Term Prepaid Expenses
  • Expenses paid in advance for benefits extending beyond one year (long-term insurance policies, rent deposits)
  • Amortized over the period of benefit

Initial Recognition and Measurement

• Long-term assets are initially recognized at their acquisition cost, which includes all costs necessary to bring the asset to its intended use
• Acquisition cost components:
  • Purchase price
  • Transportation and handling costs
  • Installation and setup costs
  • Professional fees (legal, consulting)
  • Costs of removing old assets and preparing the site
• Capitalized interest: Borrowing costs directly attributable to the acquisition or construction of a qualifying asset are capitalized as part of the asset's cost
• Assets acquired through exchange are recorded at the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident
• Donated assets are recorded at their fair value at the date of donation
• Subsequent costs that extend the asset's useful life, increase its capacity, or improve its efficiency are capitalized; otherwise, they are expensed as incurred

Depreciation Methods

• Depreciation is the systematic allocation of an asset's cost over its useful life
• Straight-Line Method
  • Allocates an equal amount of depreciation expense each period
  • Formula: $(Cost - Salvage Value) / Useful Life$
• Units-of-Production Method
  • Allocates depreciation based on the asset's usage or output
  • Formula: $(Cost - Salvage Value) \times (Units Produced / Total Estimated Units)$
• Declining Balance Methods
  • Accelerated depreciation methods that allocate more expense in earlier years
  • Double-Declining Balance (DDB): Applies twice the straight-line rate to the asset's book value each period
  • Sum-of-the-Years' Digits (SYD): Allocates a fraction of the depreciable cost each period based on the remaining useful life
• Depreciation begins when the asset is available for use and ends when the asset is fully depreciated, disposed of, or classified as held for sale

Impairment and Revaluation

• Impairment occurs when an asset's carrying amount exceeds its recoverable amount (higher of fair value less costs to sell and value in use)
• Indicators of impairment:
  • Significant decline in market value
  • Adverse changes in technology, market, or legal environment
  • Accumulated losses or negative cash flows
  • Plans to dispose of or restructure the asset
• Impairment loss is recognized in the income statement and the asset's carrying amount is reduced to its recoverable amount
• Reversal of impairment loss is permitted in some cases if the recoverable amount subsequently increases
• Revaluation model (alternative to cost model)
  • Allows long-term assets to be carried at their fair value less subsequent depreciation and impairment
  • Revaluation surplus is recognized in other comprehensive income and accumulated in equity
  • Revaluation decrease is recognized in the income statement, except to the extent it reverses a previous revaluation surplus

Disposal and Derecognition

• Long-term assets are derecognized when they are disposed of or when no future economic benefits are expected from their use or disposal
• Disposal methods:
  • Sale: Asset is sold to a third party
  • Abandonment: Asset is permanently removed from use without sale
  • Exchange: Asset is traded for another asset
• Gain or loss on disposal is calculated as the difference between the net disposal proceeds and the asset's carrying amount
• Gain or loss is recognized in the income statement in the period of disposal
• Depreciation continues until the date of disposal or classification as held for sale
• Assets classified as held for sale are measured at the lower of their carrying amount and fair value less costs to sell, and depreciation ceases

Financial Statement Impact

• Long-term assets are reported on the balance sheet under the non-current assets section
• Depreciation expense is recognized in the income statement each period, reducing net income
• Accumulated depreciation is a contra-asset account that reduces the carrying amount of the related long-term asset on the balance sheet
• Impairment losses are recognized in the income statement, reducing net income
• Revaluation increases are recognized in other comprehensive income and accumulated in equity, while revaluation decreases are recognized in the income statement
• Gains or losses on disposal are recognized in the income statement, affecting net income
• Cash outflows for the acquisition of long-term assets are reported in the investing activities section of the cash flow statement
• Non-cash transactions (exchanges, donations) are disclosed in the notes to the financial statements

Key Calculations and Formulas

• Straight-Line Depreciation: $(Cost - Salvage Value) / Useful Life$
• Units-of-Production Depreciation: $(Cost - Salvage Value) \times (Units Produced / Total Estimated Units)$
• Double-Declining Balance (DDB) Depreciation: $2 \times (1 / Useful Life) \times Book Value$
• Sum-of-the-Years' Digits (SYD) Depreciation: $(Cost - Salvage Value) \times (Remaining Life / SYD)$
  • SYD = $n(n+1)/2$, where n is the useful life
• Impairment Loss: $Carrying Amount - Recoverable Amount$
• Gain or Loss on Disposal: $Net Disposal Proceeds - Carrying Amount$
• Capitalized Interest: $Expenditures \times Capitalization Rate$
  • Capitalization Rate = Weighted average interest rate on borrowings