Howe companies account for long term assets
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What are Long Term Assets?
Long term assets are assets that a company uses in its production process and with a useful life of more than one year. Such assets are also called “fixed assets,” as they can contribute to a big portion of the company’s fixed costs associated with production. For example, an automobile manufacturer might consider factories to be long term assets since they are at the core of the business’ production process.
Regardless of the company’s monthly or yearly output, the costs associated with running the factories do not fluctuate greatly and represent a significant portion of the company’s cost of goods sold (COGS). The factories would be treated as long term assets. The assets also need to be depreciated over the course of their useful lives. In summary:
Depreciation of Long Term Assets
As with most types of assets, long term assets needs to be depreciated over the course of their useful life. It is because a long term asset is not expected to generate a benefit for an infinite amount of time. In the automobile factory example, machines will become old and may experience breakdowns or fall victim to obsolescence.
There are many accounting treatments a company can use to depreciate its assets, such as the double-declining balance method, the units of production method, or the straight-line depreciation method. It is important to note that depreciation is not considered a cash expense for the company.
Depreciation amounts that are incurred for the purposes of depreciating fixed assets provide a tax shield for the company’s income. Depreciation is subtracted from EBITDA to calculate taxable income, and then tax expense.
Long Term Asset Terminology
In order to better understand how long term assets affect a company’s financial health, it is important to become familiar with some terminology.
Property, Plant, and Equipment
Property, plant, and equipment (PP&E) refers to the long term assets that a company owns, and that are crucial to the production process. Property refers to any property or proprietary assets that the company employs in its production. Plant refers to buildings and factories that are required for production.
For example, if a company decides to purchase the land on which its factories reside, this land would be counted under the PP&E account. Equipment refers to machines and other production aids that a company utilizes in its manufacturing process. Generally speaking, the majority of a company’s long term (or fixed) assets fall under this category.
Book Value
When a company acquires PP&E or other long term assets, it initially records the value of the assets at the time of purchase, which becomes their “book value.” The number is usually recorded as the purchase price that was paid by the company in order to acquire the asset.
Carrying Value
The carrying value of a long term asset (also called the net book value) refers to the value of the asset on the company’s books. The carrying value is the original cost of the asset less any accumulated depreciation. It can be thought of as the historical accounting value of the asset.
Below is an example of what long term assets such as PP&E would look like on a company’s balance sheet:
As we can see here, Amazon’s PP&E account grew substantially, from $29 billion in 2016 to $49 billion in 2017. This could be an indication that Amazon is pursuing capital-intensive projects and is investing in long term assets to sustain this expansion.
Applications in Financial Modeling
Long term assets are a crucial element of a company’s balance sheet and are required in order to accurately calculate the equivalent liabilities and shareholder’s equity. Below is a screenshot of CFI’s Balance Sheet Template:
To further understand the relationship between the various line items on a company’s balance sheet and how they relate to the company’s income and cash flow statements, check out CFI’s Accounting Fundamentals Course.
Additional Resources
CFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following CFI resources:
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