Accounting for Long-term Assets (Lecture 8)
In this free online accounting lesson we define terms related to fixed assets: tangible and intangible assets, property, plan and equipment, natural resources, land, specifically identifiable intangible assets, goodwill, depreciation, amortization and depletion. We then talk about historical cost, basket purchases and relative fair value method. After that we discuss in detail depreciation methods like straight-line and accelerated methods (double-declining, units of production, sum of the year digits). Finally, we understand accounting for depreciation, including usage of contra asset accounts such as Accumulated Depreciation. Accounting examples are provided for most learning objectives.
8.1 Nature of fixed assets and their cost allocation
Almost any company utilizes long-term assets. Examples of such assets are trucks for transportation companies or computers, tables and chairs for software development companies. What does "long term" mean? As a rule, "long term" refers to more than a year. So, long-term assets are those whose economic life (the period of their being used by a company) is longer than a year.
Long-term operational assets are defined as recourses with economic lives of more than a year that a business possesses and uses in generating revenue.
The cost of long-term assets is recognized as an expense in the accounting periods in which they are used. So, if a table is expected to have an economic life of three years, then the table cost will be allocated over this three-year period.
Long-term assets can be tangible and intangible.
Tangible assets are those which one can touch and include natural recourses, machinery, tools, equipment, buildings and land, among others.
Intangible assets may be represented by a piece of paper or document. The real value of such assets is the rights and privileges extended to their owners. Examples of intangible assets can be patents, trademarks and customer lists.
8.1.1 Categories of fixed assets
Tangible assets are divided into three categories: property, plant and equipment; natural resources; and land.
Property, plant, and equipment include furniture, cash registers, computers, and others. In order to keep track of all assets in this category an entity can assign subcategories for a particular item or items of similar nature. The process of expense recognition for property, plan, and equipment is called depreciation.
Depreciation is allocation of the cost of property, plant, and equipment to expenses over their useful (economic) life in a systematic and rational manner.
Natural recourses consist in (but not limited to) gas reserves, reserves of timber, mines, and so on. These assets are sometimes called wasting recourses because their value diminishes as the recourses are removed and used. The process of expense recognition for natural recourses is called depletion.
Depletion is allocation of the cost of natural resources to expenses in a systematic and rational manner over the resources useful life.
Land is classified as a separate category for one major reason - land is not a subject to depreciation or depletion. Land is considered to have an infinite life, which makes it impossible to estimate its depreciation or depletion.
Intangible assets also fall into a few categories: specifically identifiable intangible assets, and goodwill and intangible assets with indefinite lives.
Specifically identifiable intangible assets can be acquired individually. They include patents, copyrights, etc. The process of expense recognition for this category of assets is called amortization.
Amortization is allocation of the cost of intangible assets to expense in a systematic and rational manner over the useful life of the asset.
Goodwill and identifiable intangible assets with indefinite lives represent the second group of intangible assets. A company can record goodwill only by purchasing another company with good reputation, established clientele, or other features that provide an above-average profit potential. Identifiable intangible assets with indefinite lives do not have definite useful lives or such lives are not practicable to determine. Examples of such intangibles may be renewable broadcast licenses or trademarks (in certain circumstances).
Neither goodwill nor intangibles with indefinite lives are subject to amortization. However, those assets are subject to the impairment test as defined by generally accepted accounting standards. We will not cover impairment in this tutorial as it extends beyond the principles level.
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