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11.6: Summary

Last updated

Nov 1, 2023
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- 11.5: Describe Some Special Issues in Accounting for Long-Term Assets
- 11.7: Practice Questions

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11.1 Distinguish between Tangible and Intangible Assets

Tangible assets are assets that have physical substance.
Long-term tangible assets are assets used in the normal course of operation of businesses that last for more than one year and are not intended to be resold.
Examples of long-term tangible assets are land, building, and machinery.
Intangible assets lack physical substance but often have value and legal rights and protections, and therefore are still assets to the firm.
Examples of intangible assets are patents, trademarks, copyrights, and goodwill.

11.2 Analyze and Classify Capitalized Costs versus Expenses

Costs incurred to purchase an asset that will be used in the day-to-day operations of the business will be capitalized and then depreciated over the useful life of that asset.
Costs incurred to purchase an asset that will not be used in the day-to-day operations, but was purchased for investment purposes, will be considered an investment asset.
Investments are short term (can be converted to cash in one year) or long term (held for over a year).
Costs incurred during the life of the asset are expensed right away if they do not extend the useful life of that asset or are capitalized if they extend the asset’s useful life.

11.3 Explain and Apply Depreciation Methods to Allocate Capitalized Costs

Fixed assets are recorded at the historical (initial) cost, including any costs to acquire the asset and get it ready for use.
Depreciation is the process of allocating the cost of using a long-term asset over its anticipated economic (useful) life. To determine depreciation, one needs the fixed asset’s historical cost, salvage value, and useful life (in years or units).
There are three main methods to calculate depreciation: the straight-line method, units-of-production method, and double-declining-balance method.
Natural resources are tangible assets occurring in nature that a company owns, which are consumed when used. Natural resources are depleted over the life of the asset, using a units-consumed method.
Intangible assets are amortized over the life of the asset. Amortization is different from depreciation as there is typically no salvage value, the straight-line method is typically used, and no accumulated amortization account is required.

11.4 Describe Accounting for Intangible Assets and Record Related Transactions

Intangible assets are expensed using amortization. This is similar to depreciation but is credited to the intangible asset rather than to a contra account.
Finite intangible assets are typically amortized using the straight-line method over the useful life of the asset.
Intangible assets with an indefinite life are not amortized but are assessed yearly for impairment.

11.5 Describe Some Special Issues in Accounting for Long-Term Assets

Because estimates are used to calculate depreciation of fixed assets, sometimes adjustments may need to be made to the asset’s useful life or to its salvage value.
To make these adjustments, the asset’s net book value is updated, and then the adjustments are made for the remaining years.
Assets are sometimes sold before the end of their useful life. These sales can result in a gain, a loss, or neither, depending on the cash received and the asset’s net book value.

Key Terms

accumulated depletion: contra account that records the total depletion expense for a natural resource over its life

accumulated depreciation: contra account that records the total depreciation expense for a fixed asset over its life

amortization: allocation of the costs of intangible assets over their useful economic lives; also, process of separating the principal and interest in loan payments over the life of a loan

capitalization: process in which a long-term asset is recorded on the balance sheet and its allocated costs are expensed on the income statement over the asset’s economic life

contra account: account paired with another account type, has an opposite normal balance to the paired account, and reduces the balance in the paired account at the end of a period

copyright: exclusive rights to reproduce and sell an artistic, literary, or musical asset

current expense: cost to the business that is charged in the current period

depletion: expense associated with consuming a natural resource

depreciation: process of allocating the costs of a tangible asset over the asset’s economic life

double-declining-balance depreciation method: accelerated depreciation method that accounts for both time and usage, so it takes more expense in the first few years of the asset’s life

fixed asset: tangible long-term asset

functional obsolescence: reduction of an asset’s value to the company, not including physical obsolescence

goodwill: value of certain favorable factors that a business possesses that allows it to generate a greater rate of return or profit; includes price paid for an acquired company above the fair value of its identifiable net assets

intangible asset: asset with financial value but no physical presence; examples include copyrights, patents, goodwill, and trademarks

investment: short-term and long-term asset that is not used in the day-to-day operations of the business

long-term asset: asset used ongoing in the normal course of business for more than one year that is not intended to be resold

natural resources: assets a company owns that are consumed when used; they are typically taken out of the earth

patent: contract providing exclusive rights to produce and sell a unique product without competition for twenty years

physical obsolescence: reduction in the value of an asset to the company based on its physical deterioration

salvage (residual) value: price that the asset will sell for or be worth as a trade-in when the useful life is over

straight-line depreciation: depreciation method that evenly splits the depreciable amount across the useful life of the asset

tangible asset: asset that has physical substance

trademark: exclusive right to a name, term, or symbol a company uses to identify itself or its products

units-of-production depreciation method: depreciation method that considers the actual usage of the asset to determine the depreciation expense

useful life: time period over which an asset cost is allocated