Reporting and Interpreting Long-Term Assets

Answer these: What can be challenging about reporting and interpreting Long term assets? What can be challenging about property, plant and equipment and depreciation? What are some challenges encountered with understanding long term investments, and intangible assets?

Introduction

The
use of long-term assets is necessary for most companies to conduct
business. Long-term assets are any assets that do not qualify as current
assets and, therefore, typically have a lifetime of 1 year or longer.
Long-term assets include fixed assets, intangible assets, and long-term
investments. Fixed assets and intangible assets typically contribute to
the bottom line in that they facilitate the ordinary course of business
and thus help to generate sales. Two important principles must be
adhered to when accounting for long-term assets: the matching principle and the cost principle.
The matching principle states that expenses must be “matched with
revenues in the period when efforts are expended to generate revenues”
(Kimmel, Weygandt, & Kieso, 2009, p. 163) and the cost principle
states that “assets be recorded at their cost” (Kimmel et al., 2009, p.
68). Therefore, when long-term assets are purchased, they must be
recorded at their cost in accordance with the cost principle and the
cost of those assets must be allocated to all of the periods of benefit
per the matching principle.

Property, Plant, and Equipment and Depreciation

Fixed
assets, also called plant assets, are tangible assets or property, such
as a plant or equipment. Fixed assets have a physical substance, are
long-term in nature, and are used in the business and not held for
resale. Property, plant, and equipment includes, among other assets,
buildings, machinery and equipment, furniture and fixtures, vehicles,
and land. Property, plant, and equipment are recorded at historical cost
in accordance with the cost principle. The cost principle dictates that
all reasonable and necessary expenditures made in acquiring and
preparing an asset for its intended use should be capitalized as part of
the cost of the asset (Libby, Libby, & Short, 2004). Subsequent
expenditures that are made to increase the productive life, operating
efficiency, or capacity of the asset are considered capital expenditures
and are added to the asset account; ordinary repairs and maintenance
are considered to be an expense in the period incurred (Libby et al.,
2004). Many assets may appreciate in market value, but the cost
principle requires that the assets not be written up to market. The only
time that appreciation in value is recognized is when the asset is sold
and the selling price exceeds the cost of the asset. At the time of the
disposition of an asset, a gain or loss is recorded.

Depreciation

Except
for land, all property, plant, and equipment are considered
depreciable. Depreciation is “the process of allocating to expense the
cost of a plant asset over its useful (service) life in a rational and
systematic manner” (Kimmel et al., 2009, p. 439). Depreciation matches
the effort of an asset against the benefit received from use. Land is
never depreciated because “its usefulness and revenue-producing ability
generally remain intact as long as the land is owned” (Kimmel et al.,
2009, p. 439). Depreciation is commonly thought of as the devaluation of
an asset, but in accounting terminology, it is more specific than that.
For accounting purposes, depreciation does not match an asset’s value
to market but rather brings down its carrying value (cost minus
previously recorded depreciation) over its useful life.

There
are several methods of depreciation that can be used to calculate the
amount of depreciation expense for a period, including straight-line
depreciation, accelerated methods (such as sum-of-the-years-digits and
double-declining-balance methods), and units of production.

·The straight-line
method is the most commonly used method by businesses because it is
relatively easy to calculate. Under the straight-line method, the
depreciation expense taken for each period of an asset’s useful life is
the same.

·Accelerateddepreciation
methods allow for more depreciation expense to be taken at the
beginning of the life of the asset than at the end. The assumption is
that the asset is more productive at the beginning of the life and will
have more repairs and maintenance expense toward the end of its life,
thus evening out the costs over the life of the asset.

·Units of production methods allocate depreciation in fixed amounts by units instead of years.

Another
way to depreciate an asset is to express its life in terms of use
rather than time. In the units of output or activity methods,
accountants express the life of an asset in terms of some activity or
output measure and then depreciate the asset as it is used up.
Depreciation entries are adjusting entries and are, therefore, required
whenever financial statements are being prepared or prior to the sale of
fixed assets in order to calculate the gain or loss on the disposition.
Depreciation on property, plant, and equipment is calculated for the
period, and depreciation expense is debited and the accumulated depreciation
account, a contra-asset account, is credited for the depreciation
adjustment. Accumulated depreciation represents all depreciation
previously taken against an asset or class of assets and is deducted
from the asset’s cost to get the asset’s book value. Property, plant,
and equipment are shown on the balance sheet net of accumulated
depreciation.

Long-Term Investments

Long-term
investments are typically investments in the debt or equity instruments
of other companies that are intended to be held for more than 1 year,
or long-term tangible assets that a company is not currently using in
operations (Kimmel et al., 2009). How the long-term investments section
is presented on the balance sheet is dependent upon the types of
long-term investments owned by the corporation.

Intangible Assets

Intangible
assets are future potential economic benefits that do not have physical
substance. Examples of intangible assets include patents, copyrights,
trademarks, franchises, and goodwill. Intangible assets may be
classified as having indefinite or limited useful lives. The useful life
of an intangible asset frequently differs from the legal life of an
intangible asset. Since many intangible assets are exclusivity rights
that are granted by the U.S. government, they have limited legal lives.
For example, a patent is a right to exclusively use technology or an
invention for a period of 20 years; 20 years is therefore the legal life
of the patent. Copyrights are exclusive rights to an artistic work that
have a legal life of the life of the creator, plus 70 years. It is
important to remember that an intangible asset cannot be expensed over a
period of more than its legal life.

The process of “expensing” an intangible asset is called amortization.
Amortization expense is calculated on a straight-line basis for all
intangible assets with limited (finite) useful lives as part of the
adjustment process. To record amortization, amortizationexpense
is debited, and the asset account is credited directly. Goodwill is
considered to have an indefinite useful life, so it is no longer
amortized, according to Generally Accepted Accounting Principles.

Conclusion

The
accountant exhibits significant judgment over accounting for long-term
assets because of the various estimates that are used in accounting for
long-term assets. The accountant estimates the useful life of assets to
be depreciated, chooses the depreciation methodology, determines the
lives of intangible assets, estimates salvage values of fixed assets,
and classifies investments. Due professional care should be used
whenever making such assessments and the accountant must remember to act
with objectivity and conservatism.

References

Kimmel, P., Weygandt, J., & Kieso, D. (2009). Accounting: Tools for business decision making (3rd ed.). Hoboken, NJ: John Wiley and Sons, Inc.

Libby, R., Libby, P., & Short, D. (2004). Financial accounting (4th ed.). Boston: McGraw-Hill/Irwin