Chapter 8: Accounting for Long-Term Operational Assets

Long-term Operational Assets

  • Definition: Assets used by a business, normally over multiple accounting periods, to generate revenue; they differ from assets that are sold (inventory) or held (investments) to generate revenue; also referred to as productive assets.

Tangible Assets

  • Definition: Physical form or presence; can be seen and touched

    • Examples:

    • Property, Plant, & Equipment (PP&E, Fixed Assets)

    • Natural Resources (e.g., oil and gas reserves, timber land, coal/copper/gold mines, stone quarries)

    • Land

Intangible Assets

  • Definition: Provide benefits through the rights or privileges conveyed to their owners; while paper evidence of their existence is usually available, the asset itself cannot be physically seen or touched.

    • Examples:

    • Identifiable (finite) lives: patents & copyrights

    • Unidentifiable (indefinite) lives: renewable franchises, trademarks, and goodwill

Current vs. Long-Term Assets

  • Current Assets: Used relatively quickly, generally within one accounting period.

    • Examples:

    • Cash

    • Accounts Receivable

    • Inventory

  • Long-Term Assets: Held for two or more accounting periods and used to produce revenue.

    • Examples:

    • Buildings

    • Equipment

    • Machinery

Accounting for the Purchase of Long-Term Assets

  • Options:

    1. Immediate/full expense at the time of purchase

    2. Capitalization, meaning to treat the cost as an Asset

  • Importance of recognizing usage over time with an expense called depreciation, which will be discussed later.

Cost of Long-Term Assets

  • Rule of Thumb: Any cost incurred to acquire the asset and prepare it for its intended use is part of the asset's cost. This includes:

    • Buildings: Purchase price, sales taxes, title fees, realtor and attorney fees, remodeling costs.

    • Equipment: Purchase price (less discounts), sales taxes, delivery and installation costs, costs to modify/adapt equipment for its intended use.

    • Land: Purchase price, sales taxes, title fees, realtor and attorney fees, costs to remove existing structures, grading, etc.

Exceptions

  • Fines or damages incurred during the acquisition/installation cannot be added to the asset's cost.

  • Proceeds from the sale of scraps or from an old asset can offset the cost.

Examples of Costs Included in Asset Capitalization

  • List Price: $140,000

  • Less: Cash Discount (4%) = $5,600

  • Transportation costs = $1,200

  • Calibration charges = $1,800

  • Journal Entry Example:

    • Account Title

    • Debit: Front Loader $134,400

    • Credit: Cash $134,400

    • Additional Entry for Calibration (when applicable).

Allocating Cost in a Basket Purchase

  • Definition: Basket purchase is the acquisition of a group of assets in a single transaction where the cost of each may not be known.

  • Use of the Relative Market Value Method for cost allocation based on appraised estimates.

    • Example: If the appraised value of assets exceeds the purchase price, use relative weights to assign costs to each asset purchased.

Example of Cost Allocation for a Basket Purchase

  • Asset Appraised Value

    • Land: $180,000

    • Building: $300,000

    • Furniture: $120,000

    • Total Appraised Value: $600,000

    • Calculated Purchase Price: $500,000 based on proportionate values.

Life Cycle of Operational Assets

  • Stages:

    • Acquire

    • Funding

    • Buy Asset

    • Use Asset

    • Retire Asset

Depreciation

  • Applicable to tangible long-term assets such as office buildings, manufacturing plants, warehouses, equipment, machinery, and vehicles.

  • Note: Land is a non-depreciable asset and carries its historical value until sold.

Depreciation Methods

Overview

  • Different depreciation methods include:

    • Straight-Line

    • Double-Declining Balance

    • Units-of-Production

  • Methods affect net income through expenses and total assets via accumulated depreciation.

Straight-Line Depreciation

  • Formula:
    extDepreciationExpense=rac(extAssetCost−extSalvageValue)extUsefulLifeext{Depreciation Expense} = rac{( ext{Asset Cost} - ext{Salvage Value})}{ ext{Useful Life}}

  • This method yields the same expense & journal entry every year.

Double-Declining Balance (DDB)

  • Description: An accelerated depreciation method that records more depreciation expense in the earlier years compared to later years.

  • Formula:
    extDepreciationExpense=rac(Cost−extAccumulatedDepreciation)imes2extUsefulLifeext{Depreciation Expense} = rac{(Cost - ext{Accumulated Depreciation}) imes 2}{ ext{Useful Life}}

Units of Production Depreciation

  • Description: Activity-based depreciation method based on actual asset usage.

  • Requires calculation of the depreciation expense rate per unit of production as follows:
    extDepreciationRateperUnit=rac(extCost−extSalvageValue)extTotalProductiveCapacityext{Depreciation Rate per Unit} = rac{( ext{Cost} - ext{Salvage Value})}{ ext{Total Productive Capacity}}

  • Example: If an asset costs $24,000, has a salvage value of $4,000, and a useful life of 100,000 miles, then:
    extDepreciationRateperMile=rac(24,000−4,000)100,000=0.20ext{Depreciation Rate per Mile} = rac{(24,000 - 4,000)}{100,000} = 0.20

Continuing Expenditures for Long-Term Operational Assets

  • Rationale: Accountants must determine how to treat costs incurred specifically for a long-term operational asset.

  • Maintenance/Repairs: Routine maintenance costs are typically expensed while improvements are capitalized.

  • Example of Treatment:

    • Routine maintenance:

    • Journal Entry:

      • Debit Repairs Expense

      • Credit Cash

    • Capital improvements:

    • Journal Entry:

      • Debit Asset Name

      • Credit Cash

Depletion of Natural Resources

  • Definition: The using up of natural resources such as timber land, oil & gas reserves, mineral deposits, coal, etc.

  • Depletion Expense: Calculated as:
    ext{Depletion Charge per Unit} imes ext{# of Units Extracted and Sold}

Intangible Assets

Overview

  • Rights or privileges that cannot be seen or touched, often documented but with no physical substance.

  • Examples of Intangible Assets:

    • Identifiable lives: Patents (20 years), and copyrights.

    • Indefinite lives: Renewable franchises, trademarks, and goodwill.

Goodwill

  • The excess of cost over the fair value of net identifiable assets acquired in a business acquisition.

  • Example: If you acquire a company for $3,000,000 and the fair value of its identifiable net assets is $3,200,000, the goodwill would be:

    • extGoodwill=extPurchasePrice−extFairValueofNetIdentifiableAssets=3,000,000−3,200,000=300,000ext{Goodwill} = ext{Purchase Price} - ext{Fair Value of Net Identifiable Assets} = 3,000,000 - 3,200,000 = 300,000

Amortization of Intangible Assets

  • Finite lived intangible assets amortized on a straight-line basis over their useful life or legal life, whichever is shorter.

  • Example: If a patent costs $44,000 and has an estimated useful life of 11 years, the annual amortization expense would be:
    extAmortizationExpense=rac44,00011=4,000ext{Amortization Expense} = rac{44,000}{11} = 4,000

Impairment Testing for Intangible Assets

  • Impairment occurs when the carrying value exceeds fair value.

  • Requires annual testing for indefinite-lived intangible assets per GAAP.

  • Loss Calculation:
    extImpairmentLoss=extBookValue−extFairValueext{Impairment Loss} = ext{Book Value} - ext{Fair Value}

Summary of Terms

Asset Types & Cost Treatment

  • Tangible Assets: Depreciation

    • Examples: PP&E, natural resources

  • Intangible Assets: Amortization for finite lives, no depreciation for indefinite lives

Summary of Depreciation & Depletion Methods

  • Straight-Line:

    • Formula: rac(Cost−SalvageValue)UsefulLiferac{(Cost - Salvage Value)}{Useful Life}

  • Double-Declining Balance:

    • Formula: rac(Cost−AccumulatedDepreciation)imes2UsefulLiferac{(Cost - Accumulated Depreciation) imes 2}{Useful Life}

  • Units of Production: Based on actual usage.

  • MACRS and Depletion: Specific for tax reporting or resource extraction.

Conclusion

  • Understanding the definitions and applications of various accounting methods for long-term operational assets is crucial for accurate financial reporting.

  • Regular updates to estimates and treatment of ongoing costs directly affect financial statements and overall asset management.