3.3 Long-term assets and liabilities

Long-term assets and liabilities are crucial components of a company's financial structure. These resources and obligations, expected to last beyond a year, play a vital role in generating future economic benefits and shaping a firm's capital structure.

Understanding the types, acquisition, measurement, and derecognition of long-term assets and liabilities is essential for accurate financial reporting. This knowledge helps in assessing a company's financial health, operational efficiency, and long-term sustainability.

Types of long-term assets

• Long-term assets are resources that a company expects to use for more than one year and are essential for generating future economic benefits
• In Intermediate Financial Accounting, understanding the different types of long-term assets is crucial for accurate financial reporting and decision-making

Tangible vs intangible assets

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• Tangible assets have a physical form and can be touched (machinery, buildings, land)
• Intangible assets lack physical substance but provide value (patents, trademarks, goodwill)
• Accounting treatment differs for tangible and intangible assets due to their nature and useful life

Depreciable vs non-depreciable assets

• Depreciable assets lose value over time due to wear and tear or obsolescence (equipment, vehicles)
• Non-depreciable assets maintain their value or appreciate over time (land)
• Depreciation expense is recognized for depreciable assets to allocate the cost over the useful life

Held for use vs held for investment

• Assets held for use are employed in a company's operations to generate revenue (manufacturing equipment)
• Assets held for investment are not used in operations but are expected to generate income or capital appreciation (rental properties)
• Classification impacts the accounting treatment and presentation on the balance sheet

Acquisition of long-term assets

• Acquiring long-term assets involves determining the cost and properly recording it in the financial statements
• Intermediate Financial Accounting delves into the nuances of asset acquisition, including capitalization of interest and asset retirement obligations

Cost of acquisition

• Cost includes the purchase price, taxes, delivery, installation, and other directly attributable costs
• Discounts or rebates are deducted from the cost
• Proper determination of cost is essential for accurate initial measurement and subsequent depreciation

Capitalization of interest costs

• Interest costs incurred during the construction or acquisition of a qualifying asset are capitalized as part of the asset's cost
• Capitalization begins when expenditures are made, and interest costs are incurred
• Capitalization ends when the asset is substantially ready for its intended use

Asset retirement obligations

• Asset retirement obligations (AROs) are legal obligations associated with the retirement of a long-lived asset
• AROs are recorded at their present value and included in the cost of the related asset
• The liability is accreted over time, and the asset is depreciated over its useful life

Depreciation of long-term assets

• Depreciation is the systematic allocation of an asset's cost over its useful life
• Intermediate Financial Accounting covers various depreciation methods and the factors influencing useful life and salvage value estimates

Depreciation methods

• Straight-line method allocates an equal amount of depreciation expense each period
• Accelerated methods (declining balance, sum-of-the-years' digits) allocate more depreciation expense in earlier years
• The choice of depreciation method should reflect the pattern of economic benefits consumed

Useful life estimation

• Useful life is the period over which an asset is expected to contribute to a company's operations
• Factors influencing useful life include wear and tear, technological obsolescence, and legal or contractual limits
• Useful life estimates are based on judgment and should be reviewed periodically

Salvage value considerations

• Salvage value (residual value) is the estimated amount a company expects to receive from the disposal of an asset at the end of its useful life
• Salvage value is deducted from the depreciable base to determine the total depreciation expense
• Salvage value estimates should be reviewed regularly and updated if necessary

Impairment of long-term assets

• Impairment occurs when the carrying amount of an asset exceeds its recoverable amount
• Intermediate Financial Accounting covers the indicators of impairment, testing process, and measurement of impairment losses

Indicators of impairment

• Significant decline in market value
• Adverse changes in the business environment or asset usage
• Deterioration of financial performance
• Plans to dispose of the asset before the end of its useful life

Impairment testing process

• Identify the asset or cash-generating unit (CGU) to be tested
• Determine the recoverable amount (higher of fair value less costs of disposal and value in use)
• Compare the recoverable amount with the carrying amount
• Recognize an impairment loss if the carrying amount exceeds the recoverable amount

Measurement of impairment loss

• Impairment loss is the difference between the carrying amount and the recoverable amount
• The loss is recognized in profit or loss and reduces the carrying amount of the asset
• Impairment losses can be reversed in future periods if conditions improve

Derecognition of long-term assets

• Derecognition occurs when a company disposes of or retires a long-term asset
• Intermediate Financial Accounting covers the accounting treatment for disposals and the calculation of gains or losses

Disposal of long-term assets

• Disposal can occur through sale, abandonment, or exchange
• The carrying amount of the asset is removed from the balance sheet
• Any proceeds from the disposal are recognized

Gains or losses on disposal

• Gain or loss is the difference between the net disposal proceeds and the carrying amount of the asset
• Gains are recognized as income, while losses are recognized as expenses
• Proper calculation and presentation of gains or losses are essential for accurate financial reporting

Types of long-term liabilities

• Long-term liabilities are obligations that a company expects to settle beyond one year or the operating cycle
• Intermediate Financial Accounting covers various types of long-term liabilities and their unique characteristics

Bonds payable

• Bonds are debt securities issued by a company to raise capital
• Bonds have a face value (par value), stated interest rate (coupon rate), and maturity date
• Bonds can be issued at par, at a discount, or at a premium

Notes payable

• Notes payable are written promises to pay a specified amount at a future date
• Notes can be secured (backed by collateral) or unsecured
• Interest is typically paid periodically, with the principal due at maturity

Leases

• Leases are contracts that convey the right to use an asset for a specified period in exchange for payments
• Finance leases transfer substantially all the risks and rewards of ownership to the lessee
• Operating leases do not transfer ownership and are treated as rental agreements

Initial recognition of long-term liabilities

• Initial recognition involves measuring the liability at its fair value and recording it on the balance sheet
• Intermediate Financial Accounting covers present value concepts, the effective interest method, and debt issuance costs

Present value concepts

• Present value is the current worth of future cash flows discounted at a specific rate
• The time value of money principle states that money available now is worth more than an identical sum in the future
• Present value techniques are used to measure the initial value of long-term liabilities

Effective interest method

• The effective interest method is used to amortize the discount or premium on a liability over its life
• The method calculates interest expense based on the effective interest rate, which equalizes the present value of cash flows with the initial carrying amount
• The effective interest method results in a constant interest rate over the life of the liability

Debt issuance costs

• Debt issuance costs are incremental costs directly attributable to the issuance of debt (legal fees, underwriting costs)
• These costs are deducted from the initial carrying amount of the liability
• Debt issuance costs are amortized over the life of the liability using the effective interest method

Subsequent measurement of long-term liabilities

• Subsequent measurement involves updating the carrying amount of the liability at each reporting date
• Intermediate Financial Accounting covers the amortization of discounts or premiums, accrual of interest, and modifications or exchanges of debt

Amortization of discount or premium

• Discounts or premiums arise when the face value of a liability differs from its initial carrying amount
• Amortization is the process of allocating the discount or premium over the life of the liability
• The effective interest method is used for amortization, resulting in a constant effective interest rate

Accrual of interest expense

• Interest expense is recognized in each period based on the outstanding liability balance and the effective interest rate
• Accrued interest is recorded as a separate current liability at each reporting date
• Interest payments reduce the accrued interest liability

Modifications or exchanges of debt

• Modifications involve changes to the terms of an existing liability (interest rate, maturity date)
• Exchanges involve replacing an existing liability with a new one
• Accounting treatment depends on whether the modification or exchange is substantial (10% cash flow test)

Derecognition of long-term liabilities

• Derecognition occurs when a company extinguishes or settles a long-term liability
• Intermediate Financial Accounting covers the accounting treatment for extinguishments and the calculation of gains or losses

Extinguishment of debt

• Extinguishment can occur through repayment, legal release, or substantial modification
• The carrying amount of the liability is removed from the balance sheet
• Any consideration paid is recognized

Gains or losses on extinguishment

• Gain or loss is the difference between the carrying amount of the liability and the consideration paid
• Gains are recognized as income, while losses are recognized as expenses
• Proper calculation and presentation of gains or losses are essential for accurate financial reporting

Presentation and disclosure

• Presentation and disclosure requirements ensure that financial statements provide relevant and reliable information to users
• Intermediate Financial Accounting covers the balance sheet classification and notes to financial statements

Balance sheet classification

• Long-term assets and liabilities are presented separately from current items
• Assets are typically classified as current, long-term investments, property, plant, and equipment, or intangible assets
• Liabilities are classified as current or long-term based on their expected settlement date

Notes to financial statements

• Notes provide additional information and explanations to support the amounts presented in the financial statements
• Notes disclose the accounting policies, assumptions, and estimates used in preparing the financial statements
• Specific disclosures are required for long-term assets (depreciation methods, useful lives) and liabilities (maturity dates, interest rates, collateral)