Deborah teaches college Accounting and has a master's degree in Educational Technology and is holds certifications as a CIA, CISA, CFSA, and CPA, CA.
Long-Term Operating Assets
The Dog Games R Us Company is in the process of constructing a new building to house its operations and is considering the purchase of new, state-of-the-art pieces of machinery that will allow it to make dog games using less plastic. The owner of the business, Mr. I. M. Shaggy wants to learn all he can about long-term operating assets before committing the company to this purchase.
An asset is something of value that a business owns. Assets can be classified as either current or long-term. To be considered long-term, assets must provide future benefit to a business for more than the next 365 days or the current year, will be used in the business, and are not purchased with the intention of selling them to consumers.
Operating assets are acquired to produce income for a business. Long-term operating assets are classified as tangible or intangible. Tangible assets have physical substance, and intangible assets are those that cannot be touched or felt. Examples of tangible assets include property, plant, and equipment and natural resources. A patent is an example of an intangible asset. A patent granted by a government authority provides an inventor with the exclusive right to use, produce, or sell his or her invention for a specified period of time.
Let's look at a few more examples of tangible assets.
Property, Plant, and Equipment
This category of tangible assets includes items like machinery, equipment, buildings, company vehicles, and land. All of these assets, except for land, get used up as they are being used to generate revenue for the company.
In order to satisfy the matching principle, the cost of using the asset must be recorded in the same financial period as the revenue that it helped to earn. In accounting, the process of allocating the cost of property, plant, and equipment assets as they are used to earn revenue is known as depreciation. Land is not subject to depreciation as it has an infinite life and its cost cannot be allocated to a particular time period.
When a company acquires an asset, the amount it records on the balance sheet (which summarizes assets, liabilities, and shareholders' equity) is known as historical cost. Historical cost reflects purchase price of the asset plus all costs incurred to get the asset ready for its intended use. In the case of the Dog Games R Us Company, the cost of the new building would include architectural fees for the drawings, the cost of building permits and the cost to construct the new building. If Dog Games R Us decides to purchase the new equipment, the cost could include transportation charges to get the piece of equipment to the company's premises, costs incurred to upgrade wiring to accommodate the new piece of machinery, and the costs incurred to build a base for the new piece of equipment to rest on in the factory.
Natural resources include standing timber and underground deposits of gas, oil, and minerals. These type of assets are physically extracted in operations, such as mining or cutting, and they are usually replaceable only by an act of nature. The cost basis for a natural resource is the cash or cash equivalent price of acquiring the resource and costs incurred in preparing it for its intended use. If the deposit on the property has already been discovered, then the cost basis becomes the price that the company paid for the property. The process of allocating the cost of natural resources over the periods in which they are used to generate revenue is known as depletion. The amount of depletion recognized on an annual basis is affected by how much of the resource is extracted, the residual value of the natural resource (what it will be worth when the extraction process is completed), and the cost of any future removal or restoration costs.
Intangible assets, such as patents and trademarks, have characteristics similar to those of tangible assets. For example, they provide benefits to the company for more than one period. Let's assume that Dog Games R Us has received a patent for its game design. On an annual basis, the company would record amortization to allocate the cost of an intangible asset in the same period as the revenue it is used to earn. Amortization is the same concept as depreciation, but it is only used for intangible assets. The amortization period for intangible assets is the shorter of their legal lives or their useful lives.
Revenue vs. Capital Expenditures
Once an asset is put into service, there are periodic costs that a company incurs to keep the asset in good working order. For example, a piece of machinery requires annual maintenance to replace parts that are worn out as it is used to produce and oil needs to be changed in the company vehicles. The costs incurred to maintain assets are known as revenue expenditures and they are expensed in the year they are incurred. They are not added to the cost of the asset as they do not lengthen its useful life. If a company were to incur an expenditure to make an asset last longer, then this cost would be added to the cost of the asset and depreciated over its useful life. This type of an expenditure is known as a capital expenditure.
Long-term operating assets are acquired and used by a company to generate revenue over a number of years. These assets are classified as either tangible or intangible and the cost to acquire them is the purchase price plus all costs necessary to get the asset ready for its intended use by the company. Tangible assets are those assets that have physical substance, such as a building or a piece of equipment. Intangible assets cannot be touched or felt; examples include patents and trademarks.
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