Introduction to Long-Lived Assets

•Definition:
Resources owned by a business, used for long periods (more than one
year) to generate revenue.
•Key Features:
• Crucial for daily operations but not intended for sale.
• Examples: Buildings, machinery, equipment, vehicles.
• Value decreases over time due to wear and tear (accounted for as
depreciation).
•Example:
• A company purchases a delivery truck for NPR 6,500,000 (approx.
USD 50,000).
• The truck will be used for several years to deliver goods, making it
a long-lived asset.
Features of Long-Lived Assets
•Key Characteristics:
• Durability: Used over multiple accounting periods (more than one
year).
• Not for Sale: Purchased to support business operations, not for resale.
• Depreciation Applies: Value decreases over time and is recorded as
depreciation.
• High Initial Cost: Requires significant investment at the time of
purchase.
•Example:
• A factory purchases machinery for NPR 26,000,000 (approx. USD
200,000).
• The machinery is durable, used for 10 years, not for resale, and its
value depreciates annually.
Types of Long-Lived Assets
A. Tangible Assets
• Physical assets you can see and touch.
• Examples: Buildings, equipment, land, vehicles, furniture.
• Depreciation: Applies to all tangible assets except land (land does not depreciate).
• Example: A school purchases desks and chairs worth NPR 1,300,000.
B. Intangible Assets
• Non-physical assets that hold value.
• Examples: Patents, trademarks, goodwill, copyrights.
• Amortization: Instead of depreciation, intangible assets are amortized (gradually
written off).
• Example: A tech company buys software rights for NPR 1,950,000.
Summary
 Long-lived assets are used over time to support business operations and are not meant for resale.
 They can be tangible (e.g., buildings, machinery) or intangible (e.g., patents, copyrights).
 Depreciation (or amortization) helps account for the reduction in their value over time.
Acquisition and Depreciation of Long-Lived Assets
•1. Acquisition Cost of Tangible Long-Lived Assets
The acquisition cost includes all expenses incurred to purchase and
prepare the asset for use.
•Key Components of Acquisition Cost:
• Purchase price of the asset.
• Transportation costs (if applicable).
• Installation or setup costs.
• Legal fees, taxes, and other necessary expenses.
•Example:
• A company in Nepal purchases machinery for NPR 800,000.
• Transportation cost: NPR 20,000
• Installation cost: NPR 10,000
• Total acquisition cost = NPR 830,000
Depreciation of Tangible Long-Lived Assets
•What is Depreciation?
Depreciation refers to the systematic allocation of the cost of a tangible
asset over its useful life. It accounts for the wear and tear, usage, or
obsolescence of the asset over time.
•Key Points:
• Depreciation is recorded as an expense in the financial statements.
• Land is the only tangible asset that is not depreciated because its value
typically appreciates over time.
•Example:
• A company buys a delivery van for NPR 1,000,000 with a useful life of 5
years.
• Depreciation for one year (using the straight-line method) will be NPR
200,000.
Meaning and Definition of Depreciation
•What is Depreciation?
Depreciation is the process of reducing the value of a
tangible asset due to wear and tear, passage of time, or
obsolescence.
•Purpose of Depreciation:
It ensures that the cost of an asset is evenly spread over
its useful life.
•Simple Definition:
Depreciation is the "loss in value" of an asset over time.
Causes of Depreciation
There are several reasons why tangible assets lose value over time:
1. Wear and Tear: Regular use of the asset leads to physical
deterioration.
o Example: A vehicle's engine becomes less efficient with usage.
2. Obsolescence: Technological advancements make the asset outdated.
o Example: Old computers replaced by new models.
3. Passage of Time: Some assets lose value simply due to aging.
o Example: Furniture made of wood deteriorates over decades.
4. Accidents or Natural Events: Unexpected events may reduce the
asset's value.
 Aspect Depreciation Amortization

Tangible assets (e.g., Intangible assets (e.g., patents,

Asset Type
machinery, vehicles). licenses).

Spread over useful life as Spread over useful life as

Method
depreciation expense. amortization expense.

A factory machine A software license is amortized

Example
depreciates over 10 years. over 5 years.

Depreciation vs. Amortization

Methods of providing Depreciation
•A. Straight-Line Method (SLM)
• Equal amount of depreciation is charged every year throughout the asset's useful life.
•Example:
• A machine costing NPR 10,00,000 with a residual value of NPR 2,00,000 and a useful life
of 4 years.
• Annual Depreciation = (Cost – Residual Value) / Useful Life
• Annual Depreciation = (NPR 10,00,000 - NPR 2,00,000) / 4 = NPR 2,00,000

B. Diminishing Balance Method (DBM):

A fixed percentage is applied to the book value of the asset each year.
Example:
A machine costing Nrs. 10,00,000 depreciated at 10% per year will have the following depreciation:
 Year 1: Nrs. 1,00,000
 Year 2: Nrs. 90,000 (10% of remaining value).
C. Units of Production Method:
 Depreciation is based on usage (hours operated, units produced).
Example:
A delivery van costing Nrs. 8,00,000 is expected to run for 1,00,000 km. If it runs 20,000 km in a
year, depreciation for that year is:
D. Depreciation Fund or Sinking Fund Method
Under this method, a fixed amount is set aside annually into a depreciation fund or sinking fund.
This fund is invested, and the interest earned helps replace the asset at the end of its useful life.
Key Features:
 Ensures funds are available to replace the asset.
 Interest income from the fund offsets the depreciation expense.
Example:
A machine costing Nrs. 6,00,000 with a 5-year life is depreciated by depositing Nrs. 1,20,000
annually into a fund. At the end of 5 years, the accumulated fund is used to purchase a replacement.
Choice of Depreciation Method
•Factors Affecting Depreciation Method:
• Nature of the Asset:
• Straight-Line Method for assets with uniform usage.
• Diminishing Balance Method for assets with higher initial utility.
• Usage Pattern:
• Units of Activity Method for assets where depreciation depends on
production or activity.
• Legal and Tax Requirements:
• Some industries or countries may mandate specific methods for tax
purposes.
• Financial Goals:
• Businesses aiming for consistent financial results may prefer the Straight-
Line Method.
Summary of Depreciation Methods
•Original Cost Method:
• Simple but may not reflect actual wear and tear.
•Diminishing Balance Method:
• Charges higher depreciation in the initial years.
•Units of Activity Method:
• Aligns depreciation with usage.
•Sinking Fund Method:
• Ensures funds are available for asset replacement.
•Conclusion:
• The choice of depreciation method depends on asset type, usage,
and financial considerations.
Disposal and Impact of Long-Lived Assets
•1. Disposal of Long-Lived Assets
Disposal refers to removing an asset from the books, either by:
• Sale: The asset is sold to another party.
• Scrapping: The asset is discarded with no resale value.
• Exchange: The asset is traded for another asset.
•Journal Entries for Disposal or Sale of Long-Lived Assets:
• Case 1: Sale of Asset at Book Value
• If the sale price equals the book value, there is no profit or loss.
• Example:
• Cost: NPR 500,000
• Accumulated Depreciation: NPR 400,000
• Sale Price: NPR 100,000
• Result: No profit or loss.
• Case 2: Sale of Asset at a Profit
• If the sale price exceeds the book value, a profit is recorded.
• Example:
• Cost: NPR 500,000
• Accumulated Depreciation: NPR 400,000
• Sale Price: NPR 200,000
• Result: Profit.
• Case 3: Sale of Asset at a Loss
• If the sale price is less than the book value, a loss is recorded.
• Example:
• Cost: NPR 500,000
• Accumulated Depreciation: NPR 400,000
• Sale Price: NPR 50,000
• Result: Loss.
Impact of Depreciation on Profit Measurement
•Key Points:
• Reduction in Profits:
• Depreciation reduces the net income reported by the company,
as it is a non-cash expense.
• Tax Benefits:
• Depreciation lowers taxable income, which results in reduced
tax liabilities for the business.
• Financial Reporting:
• By accounting for depreciation, the business presents a more
realistic view of asset usage and cost allocation over time.
Summary
- Disposal of assets involves recording entries
for sale, profit, or loss, depending on the
transaction.
- Depreciation significantly affects profit
measurement, showing the realistic cost of
asset usage and ensuring accurate financial
reporting.
Capital Expenditure and Revenue Expenses
•1. Capital Expenditure
Capital expenditure refers to the money spent by a business on acquiring,
upgrading, or maintaining long-term assets such as buildings, equipment, or
vehicles. These expenditures aim to improve the earning capacity or extend the
useful life of the asset.
•Characteristics of Capital Expenditure:
• Provides benefits over several accounting periods.
• Recorded as an asset on the balance sheet.
• Often involves large, one-time investments.
•Examples of Capital Expenditure (in NPR):
• Purchase of machinery for NPR 20,00,000.
• Construction of a new office building costing NPR 50,00,000.
• Installation of advanced software worth NPR 5,00,000.
2. Revenue Expense
Revenue expense refers to the costs incurred during normal business operations to
maintain the earning capacity of the business for the current accounting period.
These are short-term expenses that do not provide benefits beyond one financial year.
Characteristics of Revenue Expense:
 Directly impacts the Profit and Loss Account.
 Provides benefits within the same accounting period.
 Typically recurring and smaller in amount.
Examples of Revenue Expense (in Nrs):
1. Payment of electricity bills amounting to Nrs. 50,000.
2. Repair and maintenance of equipment costing Nrs. 25,000.
3. Salaries of employees totaling Nrs. 3,00,000 for the month.
 Difference Between Capital Expenditure and Revenue Expense
Aspect Capital Expenditure Revenue Expense
Nature Long-term investment. Short-term operational cost.
Recorded as an asset on the balance Charged to the Profit and Loss
Accounting Treatment
sheet. Account.
Benefits extend over multiple Benefits are limited to the
Benefit Period
accounting periods. current period.
Enhances earning capacity or asset Maintains existing earning
Purpose
life. capacity.
Purchase of machinery, building Repairs, utility bills, employee
Examples
construction. salaries.
Capital Expenditure vs. Revenue Expense
•Scenario:
• A company spends NPR 10,00,000 to buy new machinery and NPR 30,000 on repairing
an old machine in the same year.
•Analysis:
• Capital Expenditure:
• The NPR 10,00,000 spent on machinery is a capital expenditure because it adds value to the business
and provides long-term benefits.
• Revenue Expense:
• The NPR 30,000 spent on repairs is a revenue expense because it is a recurring cost to maintain an
existing asset.
•Summary:
• Capital Expenditure involves significant investments to improve long-term productivity
or capacity.
• Revenue Expense relates to day-to-day costs necessary to maintain business operations
within the accounting year.
• Proper distinction between the two ensures accurate financial reporting and informed
Financial Analysis of Long-Lived Assets
•1. Effects of Long-Lived Assets in the Balance Sheet
Long-lived assets are recorded under non-current assets. Their value reflects the
organization's investment in assets that generate revenue over multiple accounting
periods.
•Key Impacts on the Balance Sheet:
• Asset Valuation: Initially recorded at acquisition cost and adjusted for depreciation.
• Depreciation: Reduces the book value of the asset over time, impacting the total assets.
• Liquidity and Solvency:
• High investments in long-lived assets may reduce liquidity.
• However, they can improve the company's solvency position if assets are efficiently utilized.
• Asset Impairment:
• If the recoverable amount of an asset is less than its carrying amount, impairment losses are
recorded, reducing the asset value.
•Example (in NPR):
• A company acquires equipment for NPR 20,00,000.
• After 5 years, due to depreciation, the book value is reduced to NPR 12,00,000, which is
Analyzing the Management of Long-Lived Assets
•Efficient Management of long-lived assets ensures:
• Optimal utilization.
• Better financial performance.
• Long-term sustainability.
•Financial Ratios to Analyze Asset Management Effectiveness:
• Asset Turnover Ratio
• Measures how efficiently a company uses its assets to generate revenue.
• Formula:
• Asset Turnover Ratio = Net Sales / Total Assets
• Interpretation:
• Higher ratio: Efficient asset usage.
• Lower ratio: Underutilization or inefficiencies.
Example
•Net Sales = NPR 50,00,000
•Average Total Assets = NPR 25,00,000
•Asset Turnover Ratio = 2
•Meaning: The company generates NPR 2
in sales for every NPR 1 invested in assets.
Return on Assets (ROA) Ratio
•Measures profitability in relation to total assets.
•Formula:
• ROA = Net Profit / Total Assets × 100
•Interpretation:
• Higher ROA: Better profitability from asset use.
• Lower ROA: Inefficiencies in asset utilization.
•Example (in NPR):
• Net Profit = NPR 10,00,000
• Average Total Assets = NPR 40,00,000
• ROA = 25%
• Meaning: The company earns 25% return on its total assets.
Summary:
•Long-lived assets significantly impact the balance
sheet.
•Asset management affects a company’s financial
health.
•Asset Turnover Ratio and ROA help evaluate asset
usage and profitability.
•Regular analysis ensures proper investment and
utilization of long-lived assets.