4.6 Long-Lived Assets - 4.6 Long-Lived Assets Explained

Key Concepts

• Capitalization vs. Expensing
• Depreciation
• Impairment
• Revaluation Model
• Disposal of Long-Lived Assets

Capitalization vs. Expensing

Capitalization involves recording an expenditure as an asset on the Balance Sheet, which is then depreciated over its useful life. Expensing, on the other hand, involves recording the expenditure as an expense on the Income Statement in the period it is incurred.

Example: If a company buys a machine for $100,000 that has a useful life of 10 years, it would capitalize the machine and depreciate it over 10 years. If the company spends $10,000 on maintenance in the first year, it would expense this amount immediately.

Depreciation

Depreciation is the systematic allocation of the cost of a long-lived asset over its useful life. It reflects the consumption of the asset's economic benefits. Common methods of depreciation include straight-line, declining balance, and units of production.

Example: A company purchases a vehicle for $50,000 with an estimated useful life of 5 years and a salvage value of $10,000. Using the straight-line method, the annual depreciation expense would be ($50,000 - $10,000) / 5 = $8,000 per year.

Impairment

Impairment occurs when the carrying amount of a long-lived asset exceeds its recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use. Impairment losses are recognized in the Income Statement.

Example: A company owns a factory building with a carrying amount of $2 million. Due to a decline in market conditions, the fair value of the building drops to $1.5 million. The company would recognize an impairment loss of $500,000.

Revaluation Model

The revaluation model allows companies to periodically revalue long-lived assets to their fair value. If the fair value exceeds the carrying amount, the surplus is recorded in other comprehensive income. If the fair value is less, the deficit is recognized in the Income Statement.

Example: A company revalues its office building from $10 million to $12 million. The $2 million increase is recorded in other comprehensive income. If the building were revalued to $8 million, the $2 million decrease would be recognized as an expense.

Disposal of Long-Lived Assets

When a long-lived asset is disposed of, the asset is removed from the Balance Sheet, and any gain or loss on disposal is recognized in the Income Statement. The gain or loss is the difference between the proceeds from disposal and the asset's carrying amount.

Example: A company sells a piece of equipment for $30,000. The equipment had a carrying amount of $25,000 after depreciation. The company would recognize a gain on disposal of $5,000 ($30,000 - $25,000).