Long-Term Investment Assets on the Balance Sheet
Understanding Their Accounting, Classification and Valuation
The balance sheet is divided into three parts: assets, liabilities, and equity. Subtract liabilities from assets and you arrive at shareholder equity, a key measure providing insight into a company's health. A company with more assets than liabilities will give its shareholders a better return on their equity than one with negative equity.
Assets on a Balance Sheet
A company can have many different kinds of assets. Some are tangible, such as inventory, cash, or machines. Some are intangible, such as goodwill, brand recognition, or copyright. A company may list its tangible assets (and externally acquired intangible assets) on its balance sheet in a few different categories, such as:
- Current assets
- Long-term investments
- Other (this may include fixed assets such as property, plant, and equipment)
Defining Long-Term Investment Assets
Long-term investment assets on a balance sheet are typically investments a company has made to help it sustain a successful and profitable future. These could include stocks or bonds from other companies, Treasury bonds, equipment, or real estate. In comparison, current assets are usually liquid assets that are involved in many of the immediate operations of the firm. These might be inventory, cash, assets held for sale, or trade and other receivables.
Investments are classified as current assets if the company intends to sell within a year. Long-term investments are assets the company intends to hold for more than a year.
If the company intends to sell an investment but not until after 12 months, it is classified as available for sale. If a company intends to hold an investment to maturity (such as a bond) it is classified as held-to-maturity.
Whether an investment is categorized as current or long-term can have implications for a company's balance sheet.
For example, say an insurance company buys $10 million worth of corporate bonds that it intends to sell at some point in the next twelve months. In this situation, the bonds will be classified as a short-term investment and subject to rules requiring them to be marked to market, or listed at current market value, at reporting time.
If the bonds decline in value to $9 million in a quarter, the $1 million loss must be posted on the company's income statement even if the bonds are still held and the loss is unrealized.
Alternatively, if this insurance company buys the same $10 million in corporate bonds but plans on holding them until maturity, they're classified as a long-term investment. The investment is recorded at cost, and as such may not reflect market changes in price.
Long-term investment assets such as plants and equipment decrease in value as they age. Depreciating these assets helps to keep fair market values assigned and allows for spreading out the expense over time.
Using Asset Valuations in Financial Ratios
Overall, the valuation of long-term investment assets at each reporting cycle is an important factor in figuring a firm’s worth on its balance sheet. The ratios an investor can calculate from these valuations are important, too. Two such ratios are return on assets and return on equity. Both of these ratios divide a company’s net income by total assets and total equity, respectively. They are different ways of showing a company's profitability.
If a company has negative equity, it means its liabilities exceed its assets and it can be considered insolvent. Startup companies may not have gathered as many assets and therefore could have negative equity in the beginning phases of business.