Long-Term Assets - In-Depth Notes

Understanding Financial Accounting - Long-Term Assets

Overview of Long-Term Assets

Long-term assets, also referred to as long-lived assets, are critical to a company’s operations and financial health. They are investments meant to generate revenue over multiple accounting periods. The major categories of long-term assets include:

• Property, Plant, and Equipment (PP&E): These tangible assets have physical substance, such as land, buildings, and machinery.

• Right-of-Use Assets: These are leased assets that a company must use for longer than one year.

• Intangible Assets: These are non-physical assets constituting legal benefits, like trademarks, patents, and copyrights.

• Goodwill: This asset arises when a company pays more than the fair value of the net identifiable assets of the acquired business, typically reflecting intangible factors such as brand reputation.

• Biological Assets: Living plants or animals being cultivated for commercial purposes (e.g., cannabis, trees).

Valuation of Long-Term Assets

Valuation is essential to ensure accuracy in financial reporting.

• Cost Model: Under IFRS, the cost model applies where assets are recorded at their acquisition cost and are depreciated over their useful lives. This is also the only model permitted under ASPE (Accounting Standards for Private Enterprises).

• Revaluation Model: This model allows for carrying assets at fair value, adjusted for accumulated depreciation and impairment losses. If one class of assets is revalued, all assets within that class must be revalued as well.

Depreciation of Property, Plant, and Equipment

Depreciation allocates the cost of PP&E over its useful life, reflecting wear and tear.

• Determining Depreciability: To compute depreciation, one must know the cost of the asset, the estimated residual value (the value at the end of its useful life), and the estimated useful life.

• Common Depreciation Methods:

  1. Straight-Line Depreciation: This method spreads the cost evenly across the life of the asset.

  • Formula: {Depreciation Expense} = {Cost} - {Residual Value}}{ {Useful Life}
    For example, for an asset costing $50,000 with a residual value of $5,000 and useful life of 5 years, the yearly expense would be rac{50,000 - 5,000}{5} = 9,000.

  1. Units-of-Production Method: Depreciation is based on usage/output rather than time.

  2. Diminishing-Balance Method: This accelerated method deducts a higher depreciation expense in the early years of an asset’s life, gradually decreasing over time. The formula involves multiplying the carrying amount by a fixed percentage based on estimated useful life, usually double the straight-line rate.

Impairment of Long-Term Assets

Impairment occurs when the carrying amount of an asset exceeds its recoverable amount. The recoverable amount is determined by comparing the total expected future cash flows against the asset's fair value less selling costs. If impairment is recognized:

• The impairment loss is recognized on the income statement.

• The asset’s carrying value must be adjusted down to the recoverable amount.

Disposal of Property, Plant, and Equipment

When disposing an asset:

1. Depreciate the Asset: The asset should be fully depreciated up to the date of disposal.

2. Derecognize the Asset: Remove the asset and its accumulated depreciation from the books. Determining any gain or loss involves comparing proceeds from the sale against the asset's carrying amount prior to disposal.

Intangible Assets and Goodwill

• Intangible Assets must meet criteria for capitalization, particularly when associated with internal development

• Goodwill arises during mergers and acquisitions; it reflects various intangible factors contributing to expected future revenues. Goodwill is not amortized but is reviewed annually for impairment.

Conclusion

The valuation and accounting treatment of long-term assets are integral to financial accounting, providing insights into a company’s investment in its operational infrastructure, both tangible and intangible. Understanding depreciation, impairment, and the disposal process further empowers accurate financial reporting. This equips practitioners to reflect a company’s economic reality in its financial statements.