Question

Explain why certain long-lived assets are capatilized and recovered over time rather than immediately expensed. Please explain in depth and provide example.

Answer 1

As per accrual system of accounting the income and expenses are recorded when they are incurred and not when cash is exchanged.

Now assets can be of 2 types:-

1. Current assets:- These are those assets which are expected to be sold, consumed or utilized through standard business operations which will eventually lead to their conversion into cash within ONE YEAR.

2. Fixed assets or Long-termed assets:- These are the assets which can'nor be turned into cash within a period of one year. Simply put they have a life of more than one year. Further under Long-term assets also it has 2 sub-parts: a) Tangible Assets b) Intangible Assets.

Now as per GAAP all the Long-term assets are to be shown in the balance sheet at there carrying value.

It means that as the asset are used for more than one year then its value is going to diminished more and more due to normal wear and tear or passage of time or obsolonce. Due to these all the Tangible assets are depreciated over the useful life of the asset and the inrtangible assets are amortized over its useful life. That depreciation or amortization is an expense and shown in the income statement.

Example:- Plant and machinery:- It is used in the production and has a life of more than 1 year. The Plant and machinery are capitalized with the purchase value and shown in the balance sheet at that amount. Now since it is a long-term asset it will be used for a long period of time and hence can'notr be recoded as an expense in the balance sheet, it has to bve shown in the Balance sheet at carrying value (Book value - Depreciation).