Long-term Asset - Explained
What is a Long-Term Asset?
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Table of ContentsWhat is a Long-Term Asset?How are Long-Term Assets Used? Determining long-term assetsExample Long-Term Assets and Current AssetsChanges in Long-Term AssetsDepreciation of Long-Term AssetsLimitations of Long-Term AssetsConclusion Academic Research on Long-Term Assets
What is a Long-Term Asset?
A long-term asset 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.
Back to: ACCOUNTING, TAX, & REPORTING
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.
Take an example of an Insurance Company XYZ that holds common stocks and bonds of various companies. The Insurance Company uses $6,000,000 in corporate bonds so that it can sell them in the next two years. Therefore, it will classify the corporate bonds as long-term assets on the balance sheet. In case the company decides to sell the bonds before the two years, then it will report them as short-term investments. If the bonds value decline to $ 4,500,000, the company will report the $1,500,000 losses on the income statement. However, if the bonds reach the maturity date, the company reports them as long-term investments on the balance sheet.
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.
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 companys 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.
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.
Academic Research on Long-Term Assets