0REVIEWING THE CHAPTER
Objective 1: Define
and explain the management issues related to them.
) are assets that (a) have a useful life of more
than one year, (b) are acquired for use in the operation of a business, and (c) are not
intended for resale to customers. Assets that are not being used in the normal course of
business, such as land held for speculative purposes, should be classified as long-term
investments rather than as long-term assets.
Property, plant, and equipment is the balance sheet classification for
are long-term assets that have physical substance, and for
long-term assets in the form of valuable substances, such as standing timber, oil and gas
fields, and mineral deposits
. Intangible assets
is the balance sheet classification for long-
term assets without physical substance whose value is based on rights or advantages
accruing to the owners; examples are patents, copyrights, trademarks, franchises, licenses,
and goodwill. The allocation of costs to different accounting periods is called
in the case of plant and equipment (plant assets),
in the case of natural resources,
in the case of intangible assets. Because land has an unlimited useful life,
its cost is not converted into an expense.
Long-term assets are generally reported at
), which is
the unexpired part of a plant asset’s cost. Carrying value is calculated by deducting
accumulated depreciation from original cost. If
(loss of revenue-
generating potential) occurs, the long-term asset’s carrying value is reduced to reflect its
current fair value (an application of conservatism). A loss for the amount of the write-down
would also be recorded. Taking a large write-down in a bad year is often called “taking a
bath,” because it presumably will reduce future depreciation or amortization and, thus, raise
the likelihood of profit realization.
Capital budgeting is the process of evaluating a decision to acquire a long-term asset. One
common capital budgeting technique compares the amount and timing of cash inflows and
outflows over the life of the asset under consideration. If the net present value of those cash
flows is positive, the asset should probably be purchased. Information about long-term asset
acquisitions may be found in the investing activities section of the statement of cash flows.
Long-term assets not purchased for cash must be financed. Common financing techniques
include issuing stock, bonds, and long-term notes.
Free cash flow
is a good measure of a
business’s ability to finance long-term assets. Specifically, it is the amount of cash that
remains after deducting the funds a company must commit to continue operating at its
planned level, and is computed as follows:
Free Cash Flow = Net Cash Flows from Operating Activities – Dividends –
(Purchases of Plant Assets – Sales of Plant Assets)