Understanding fixed asset accounting is an essential part of managing and maintaining a correct ledgers account. Therefore, this aspect of financial accounting is vital for any entrepreneur, CFO, or controller. To start with, fixed asset accounting entails recording and valuating assets periodically to ensure every variable is accounted for in the income and balance sheet statements. This way, key aspects such as depreciation and capitalization receive adequate coverage.
Fixed Asset Accounting
Things you should always do/ consider when doing fixed asset accounting:
- Consider all costs at the time of acquisition or construction; this value is crucial because it would be the book value/ historical cost assigned to the asset. Where after, it allows an accountant to depreciate the asset for its useful years.
- Adopt a capitalization policy; understand how to monetize fixed assets in the business through the mechanistic role in producing an organization's revenue-generating products.
- Estimate useful life for depreciation based on an asset's estimated service life; determining the fixed assets useful life allows the company to depreciate, dispose, and account for the asset. This aspect is pivotal because it will enable a company to know and understand the underperforming fixed assets.
- Consider whether the asset will have value at the end of its service life, then base depreciation on cost, less estimated salvage value.
- Keep your depreciation records in sufficient detail so that assets can be accurately tracked when physically disposed of or moved.
- Consider asset impairment when significant events or changes in circumstances occur.
- Consider expense costs such as sales tax or freight incurred on a fixed asset purchase.
- Use depreciable lives based on Internal Revenue Service rules for financial reporting purposes.
- Ignore changes in an asset's use or service; you may need to consider asset impairment.
- Automatically depreciate a leased asset over its useful life; consider lease accounting to determine proper life.
- Forget to consider insurance record keeping requirements when recording and to track fixed assets.
What's the difference between assets and fixed assets?
Assets are mainly categorized as fixed or current; therefore, existing assets refer to the short-term assets that an organization uses and disposes within a year. Existing assets find use in the day-to-day operations of a business to keep it running. Some of the notable examples of current assets are such as cash, account receivables, and inventory.
On the other hand, fixed assets are long-term, physical assets used to generate and provide infrastructural support to a business. Mostly, fixed assets such as plant and equipment fall under this category. It would be worthy to note that fixed assets usually have a useful life of more than one year.
What classifies as a fixed asset?
To understand what can be classified as a fixed asset in accounting, it is essential to internalize that a fixed asset is a long-term tangible piece of property or equipment that a firm owns and uses in its operations to generate income. In addition to this, fixed assets are not expected to be consumed or converted into cash within a year. Fixed assets most commonly appear on the balance sheet as property, plant, and equipment (PP&E). That's why fixed assets are a capital expenditure because of its long-term existence in an organization's structure and financial records.
Key Factors to Keep In Mind about Fixed Assets
- They have a useful life of more than one year.
- They are depreciable.
- Their use is in business operations and provides long-term financial gain.
- They are illiquid, which means they are not easy to convert.
Impairment testing in Fixed Asset accounting infers to the valuation of properties to determine whether their value is consistent with their input or vice versa. This approach is instrumental in identifying the assets that require disposal, upgrading, or a complete replacement. While at it, some of the factors that can cause a fixed asset to be impaired are;
- Obsolescence due to new technological changes
- A decline in performance, i.e. (negative net cash flows of the operating asset)
- A drastic decrease in the fixed asset's market value
- Lots of adverse changes in the economy, such as an increase in labor costs, raw materials, which shrink the net cash flows of the asset
- Any physical damage to the asset such as fire or other accidents that messes with its optimal performance/ contribution to the company
- Significant restructuring and business re-engineering strategies are undertaken, such as reshuffling products, segments and acquiring new assets.
Generally, fixed assets' capitalization infers to when an asset is recorded at its cost and expensed over its useful years instead of periodical expensing. Therefore, the asset's initial value is recorded from purchase until disposal. We refer to this approach of expensing fixed assets as capitalization due to its long term recognition in the book of accounts during its existence in the company.
Similarly, depreciation is the expensing/cost of a fixed asset's incurred (monetary) value during a specific operating period. This way, it allows and accrues all the used value of an asset during its useful years to provide the salvage value in line with the accounting/ depreciation method.
Some considerations when depreciating fixed asset;
- Type of asset
- The condition when purchased: New or used
- Expected usage: Normal or excessive
- Expected obsolescence
What Should You Do When Managing Your Fixed Asset Accounting
Purchasing; ensure the asset is new or has adequate, useful lives compared to alternatives
Recording; understand and state the fixed asset's useful life together with its depreciation method.
Auditing; Make sure records are valid and verifiable, plus the depreciation schedule is consistent and denote any changes in accounting periods or methods.
Disposing and Reporting Fixed Assets; Make sure the disposal value, when added with the depreciable amount, equals the initial (historical) cost recorded during the purchase of the fixed asset. Any gain or loss endured during the process is recorded in its respective ledger account.
What Shouldn't You Do?
- Never use or compare competitors' asset depreciable schedule because the purchase price and usage are different.
- Do not purchase fixed assets that cannot be verified through a valid government receipt or notification.
Assertive Industries, Inc. has been managing fixed assets for companies around the globe for nearly 30 years. We are a premier and industry-leading fixed asset company. Call today for a free consultation.