Long-Term Assets and Their Accounting

Long-Term Assets

  • Definition: Long-term assets are crucial for generating revenue and can be classified into two major categories:

    1. Tangible Assets: Physical assets such as land, buildings, and equipment.
    2. Intangible Assets: Non-physical assets like patents, copyrights, trademarks, and goodwill.

  • Recording Costs:

    • Long-term assets are recorded at their acquisition cost plus all necessary expenditures to prepare them for use.
    • Examples:
    • Land: Includes price, closing costs, back taxes, and preparation costs.
    • Buildings: Includes purchase costs, realtor commissions, and potential remodel costs.
    • Equipment: Encompasses purchase price, delivery, installation, and sales tax, but not annual insurance.

Capitalized Costs

  • Land Costs:

    • Capitalization: Includes purchase price, improvement costs, fees, and clearing costs.
    • Example: Olive Garden's total capitalized land cost might include a purchase price of $500,000 plus additional costs resulting in a total of $590,000.

  • Equipment Costs:

    • Components: Purchase price, sales tax, shipping, installation, but notably not recurring insurance costs.
    • Example Computation: For Olive Garden, total equipment cost is $91,000.

Intangible Assets

  • Definition: Non-physical assets that have value, including patents and copyrights.
  • Acquisition: Can be purchased or developed internally but most R&D costs are expensed immediately.
  • Valuation Challenges: Difficulties in estimating future benefits lead to current accounting rules that require expensing many costs.

Depreciation and Amortization

  • Depreciation: Allocation of an asset's cost over its service life.

    • Methods: Straight-line, declining balance, and activity-based.

  • Amortization: Similar allocation process for intangible assets.

  • Factors in Depreciation:

    1. Service Life: Estimated time the asset will be useful.
    2. Residual Value: Estimated value at the end of its useful life.
    3. Method of Depreciation: Chosen based on the asset usage pattern.

  • Common Misunderstandings: Depreciation doesn’t represent actual value changes but the systematic allocation of cost.

Sales and Disposal of Assets

  • Gains and Losses: Recorded based on the difference between cash received and the book value of the asset.
  • Example: A gain occurs when the selling price exceeds the book value; a loss occurs when it falls below.

Return on Assets (ROA)

  • Formula: ROA = Net Income / Average Total Assets

  • Importance: A more accurate measure of profitability that accounts for the size of the company.

  • Note on Materiality: Material items impacting financial reporting should be consistently handled, especially expenditures affecting long-term assets.