Long-Term Asset - Explained
What is a Long-Term Asset?
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Table of ContentsWhat is a Long-Term Asset?What are Plant Asset?How are Long-Term Assets Used? Determining long-term assetsWhat is a Lump Sum Purchase of Long-Term Assets?Long-Term Assets and Current AssetsChanges in Long-Term AssetsHow to Compute the Cost of a Long-term AssetDepreciation of Long-Term AssetsLimitations of Long-Term AssetsHow to Dispose of Long-Term Assets?Conclusion
What is a Long-Term Asset?
A long-term asset, often known as Plant Assets, is an investment that a company preserves and does not convert into liquid cash for a period of about one or more years. For example, if a company operates on a cycle that is more than a year, they cannot convert any long-term assets into cash. Long-term assets are fixed assets, long-lived assets, or non-current assets.
What are Plant Asset?
The categories of plant assets are generally divided into depreciable assets and non-depreciable assets. A depreciable asset is one that is used up over time. Depreciation is an expense; whereas, non-depreciable assets are not expensed.
- Land - Has unlimited life and is not expensed.
- Land Improvement - These are costs that increase the usefulness of the land. These can be depreciated or expensed.
- Buildings - Located on and attached to the land.
- Machinery Equipment - Used in the conduct of business.
See our article on Property, Plant, and Equipment.
How are Long-Term Assets Used?
Long-term assets make a large percentage of the company's overall fixed costs, which will be advantageous in the future. Data on an organizations long-term assets is important as it helps to make accurate financial reports, business valuations, and analysis of the organizations finances. The company reports long-term assets on their balance sheets every financial year. It records the first purchase price of the asset and not the value that the asset currently represents. Long-term assets comprise of tangible and intangible assets. Examples of long-term assets include:
- Long-term investments to include the company's investments in stocks and bonds, any property it's waiting to sell, and its bond sinking fund. Long-term investments can also include the value of the company's life insurance policy.
- Any intangible assets that the company acquires in a transaction for example; patents, customer lists, trademarks, copyrights, domain names, and goodwill.
- Property plant and equipment. The classification comprises of buildings, land, machinery, vehicles, fixtures, and any other equipment that the company uses to run the business.
- Deferred assets are a classification of assets that do fit in any of the above categories. Deferred assets are assets that the company pays in advance, for example; prepaid rent or insurance to acquire the service.
Determining long-term assets
There is no formula in accounting that classifies an asset as a long-term asset. The company lists the assets with a valuable life as long-term assets in the balance sheet. The lifetime of a long-term asset must be more than one year. A long-term asset cannot be put in the same category as a current asset, as a company can easily convert a current asset into cash in a year.
The balance sheet provides information on the company's liabilities, shareholder equity, and assets, including both long-term and current assets. In the balance sheet; Assets = shareholder equity + liabilities The equation is so because a company can only purchase its assets using the capital it obtains from shareholder equity and debt payments.
What is a Lump Sum Purchase of Long-Term Assets?
The below video explains the process for determining the cost or value of assets when they are purchase multiple assets in a single transaction. This is also known as Basket Purchases.
Long-Term Assets and Current Assets
The two main assets that a company displays on its balance sheet are current and non-current assets or long-term assets. As earlier explained, current assets are all assets that a company can convert into liquid cash within one year. Most companies depend on money from current assets to fund their daily operations and expenses. Non-current assets are illiquid, as it takes the company a lot of time to convert them into liquid cash.
Changes in Long-Term Assets
Capital investments or liquidation of assets can arise from any changes in long-term assets. For example, a company that wants to invest in its economic growth will use its capital to purchase various assets. However, investors should know that not all companies keep their long-term assets for more than a year. Some companies raise their operational costs or pay debts by selling their long-term assets. Circumstances like this would mean that the company isn't in a good financial state.
How to Compute the Cost of a Long-term Asset
The below video explains the process of determining the total asset cost of a Plant Asset.
Depreciation of Long-Term Assets
The value of long-term assets depreciates in the course of its lifetime because the assets cannot last the company to eternity. The machines in an automobile company may breakdown after years of service, or they may become old. The value of the machine in its current state cannot be the same as its value when it was new. The methods a company can use to depreciate its assets include;
- Straight-line depreciation method
- Units of production method
- Double-declining balance method
- Depreciation allows a company to estimate its non-cash expenses during the financial year as they prepare the balance sheet.
Limitations of Long-Term Assets
Some of the disadvantages of long-term investments are;
- Investing in long-term assets requires the company to use a lot of capital, which may drain the company's cash or increase its debt
- Investing in long-term assets is similar to investing in stocks and bonds, as it takes a long period for investors to see the financial benefits. Investors have no other option, but to trust the management to make wise decisions in their investment plans
- Not all long-term assets that a company invests in are profitable. For example, a drug company may invest a lot of cash in researching drugs, but the drugs may not make it in the market.
How to Dispose of Long-Term Assets?
At the end of the long-term or plant assets, there are there options for disposing of the asset:
- Discard - Scraping the asset after it's useful life.
- Sale - Trade the asset for cash.
- Exchange - Trade the asset for another asset.
Investors need to analyze a company's long-term assets before making an investment decision, as not all investments generate profits. It is wise for an investor to make use of the different financial metrics and ratios when analyzing the financial state of a company.
- Depreciation, Depletion, and Amortization
- How Reporting Depreciation for Tax is Unique? – Financial Accounting
- What happens when Depreciation Estimates Change? – Financial Accounting
- What are Capital Expenditures? – Financial Accounting
- How to Dispose of Plant Assets? – Financial Accounting