Long-term assets form the backbone of a company’s operational capacity, representing significant investments that provide economic benefits for more than one year. Understanding how to properly account for these assets and calculate their depreciation is essential for accurate financial reporting and strategic business planning.
Whether you’re an accounting student preparing for exams or a professional managing corporate assets, this comprehensive guide will walk you through everything you need to know about long-term assets and their depreciation methods.
What Are Long-Term Assets?
Definition and Characteristics
Long-term assets, also known as non-current assets or fixed assets, are resources owned by a company that:
- Provide economic benefit for more than one year
- Are not intended for immediate sale
- Support the company’s operations and revenue generation
- Appear on the balance sheet below current assets
These assets are crucial for business operations but cannot be quickly converted to cash like current assets such as inventory or accounts receivable.
Long-Term vs. Current Assets
Understanding the distinction between long-term and current assets is fundamental to financial accounting:
Types of Long-Term Assets
Tangible Assets
Tangible long-term assets are physical items you can touch and see. Here are the primary categories:
1. Land
Land is unique among long-term assets because it doesn’t depreciate. Its value is recorded separately from any buildings or structures on it. Companies often hold land for future development or as an investment.
2. Buildings
Buildings used for operations, whether owned offices, warehouses, or retail locations, are depreciated over their useful life, typically 20-40 years depending on the structure type and local regulations.
3. Vehicles
Company vehicles including cars, trucks, and delivery vans are recorded at their market value when placed into service. These assets typically depreciate over 3-7 years.
4. Equipment
This category includes:
- Computers and technology infrastructure
- Manufacturing machinery
- Office equipment (copiers, phone systems)
- Point-of-sale systems
5. Furniture and Fixtures
Office furniture, store fixtures, and warehouse shelving systems that the business expects to use for multiple years.
Intangible Assets
Intangible assets lack physical substance but provide significant value:
- Patents: Exclusive rights to inventions (20-year life)
- Trademarks: Brand names and logos (indefinite life)
- Copyrights: Creative works protection (author’s life plus 70 years)
- Goodwill: Value above net assets in acquisitions
- Software licenses: Multi-year usage rights
Understanding Depreciation
Depreciation is the systematic allocation of an asset’s cost over its useful life. It serves two primary purposes:
- Matching Principle: Expenses are matched with the revenues they help generate
- Asset Valuation: Book value reflects the asset’s declining utility over time
Key Concept: Depreciation is a non-cash expense that reduces taxable income while the actual cash outflow occurred when the asset was purchased.
Depreciation Methods for Long-Term Assets Explained
Choosing the right depreciation method impacts financial statements and tax obligations. Let’s examine each method with practical examples:
1. Straight-Line Depreciation
The most common method, straight-line depreciation allocates equal amounts each year.
Formula: (Cost – Salvage Value) ÷ Useful Life = Annual Depreciation
Example: A delivery truck costing $50,000 with a $5,000 salvage value and 5-year life:
2. Double-Declining Balance Method
This accelerated method front-loads depreciation expense, useful for assets that lose value quickly.
Formula: 2 × (1/Useful Life) × Book Value = Annual Depreciation
Example: Same $50,000 truck with 5-year life:
3. Units of Production Method
This method ties depreciation to actual usage, ideal for manufacturing equipment.
Formula: (Cost – Salvage Value) ÷ Total Units × Units This Period = Depreciation
4. Sum-of-Years-Digits Method
Another accelerated method using a fraction based on the asset’s useful life.
Accounting for Long-Term Assets
Initial Recording
When acquiring a long-term asset, record all costs necessary to make it operational:
- Purchase price
- Transportation and installation
- Legal fees
- Site preparation costs
Journal Entry Examples
Purchasing Equipment for $25,000 cash:
Equipment 25,000
Cash 25,000
Recording Monthly Depreciation of $500:
Depreciation Expense 500
Accumulated Depreciation 500
Balance Sheet Presentation
Long-term assets appear on the balance sheet in order of permanence, with their accumulated depreciation shown as a contra asset:
Special Considerations
Leasehold Improvements
Improvements to leased property are depreciated over the shorter of:
- The improvement’s useful life
- The remaining lease term
Asset Impairment
When an asset’s fair value falls below its book value permanently, an impairment loss must be recognized. This often occurs with:
- Technological obsolescence
- Physical damage
- Legal restrictions
- Market changes
Tax vs. Book Depreciation
Companies often maintain two depreciation schedules:
- Book Depreciation: For financial reporting (GAAP)
- Tax Depreciation: Following IRS guidelines (MACRS)
Common Long-Term Assets by Industry
Different industries rely on different types of long-term assets:
Best Practices for Long-Term Asset Management
Effective long-term asset management requires:
- Regular Physical Audits: Verify assets exist and assess condition
- Accurate Record-Keeping: Maintain detailed asset registers
- Periodic Useful Life Reviews: Adjust depreciation if circumstances change
- Disposal Documentation: Track sales, retirements, and write-offs
- Insurance Coverage: Ensure adequate protection for valuable assets
Impact on Financial Analysis
Long-term assets significantly affect key financial ratios:
- Asset Turnover: Sales ÷ Average Total Assets
- Return on Assets: Net Income ÷ Average Total Assets
- Fixed Asset Turnover: Sales ÷ Average Fixed Assets
Understanding these relationships helps in evaluating management effectiveness and comparing companies within industries.
Preparing for the CPA Exam
Long-term assets and depreciation are heavily tested topics on the CPA exam. Focus on:
- Calculating depreciation under different methods
- Understanding capitalization vs. expense decisions
- Asset impairment testing procedures
- Differences between GAAP and tax treatment
- International accounting standards (IFRS) variations
Conclusion
Mastering long-term asset accounting and depreciation methods is essential for accurate financial reporting and effective business management. Whether you’re calculating straight-line depreciation for a building or determining the best method for new equipment, understanding these concepts ensures compliance with accounting standards and provides valuable insights for decision-making.
As you continue your accounting education or professional development, remember that long-term assets represent significant investments that shape a company’s operational capacity and financial position for years to come.
Note: This guide provides educational information about accounting principles. Consult with a qualified CPA or accounting professional for specific business advice and current tax regulations.
