Fixed Asset Accounting Explained
/What is a Fixed Asset?
A fixed asset is property that can be used for an extended period of time in business operations. Common examples include buildings, machinery, vehicles, and equipment. It has a useful life that spans multiple reporting periods, and whose cost exceeds a certain minimum limit (called the capitalization limit). After recognition, the cost of a fixed asset is systematically allocated to expense through depreciation over its useful life. It is classified as a long-term asset, since it will remain on your books for an extended period of time. In a capital-intensive business, fixed assets may very well be the largest asset class on an organization’s balance sheet.
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Examples of Fixed Assets
In an organization’s accounting records, there is a separate account for each general type of fixed asset. When a newly-acquired fixed asset is recognized, it is stored in one of these accounts. The more common fixed asset accounts are noted below:
Buildings. Includes all facilities owned by the entity. This account also includes buildings constructed by the organization.
Computer equipment. Includes all types of computer equipment, such as servers, desktop computers, and laptops.
Computer software. Usually only includes the most expensive types of software; all others are charged to expense as incurred.
Construction in progress. This is an accumulation account in which are recorded the costs of construction. Once an asset (usually a building) is completed, the balance is moved to the relevant fixed asset account.
Furniture and fixtures. Includes tables, chairs, filing cabinets, cubicle walls, and so forth.
Intangible assets. Includes all nontangible assets, such as the costs of patents, radio licenses, and copyrights.
Land. Includes the purchased cost of land, and may also include the cost of land improvements (which are otherwise recorded in a separate account).
Leasehold improvements. Includes the costs incurred to renovate leased space.
Machinery. Typically refers to production machinery.
Office equipment. Includes copiers and similar administrative equipment, but not computers (for which there is a separate account).
Tools. A production business might elect to record the cost of its tools within a separate classification, though only if there is a substantial investment in tools. Lower-cost tools may be charged to expense as incurred.
Vehicles. Can include company cars, trucks, and more specialized moving equipment, such as fork lifts.
Warehouses. A business that owns a number of warehouses may elect to record these structures within a separate classification.
How to Account for Fixed Assets
There are several accounting transactions to record for fixed assets, which are noted below. Some of these transactions will need to be repeated several times over the useful life of an asset.
Step 1: Initial Asset Recordation
On the assumption that the asset was purchased on credit, the initial entry is a credit to accounts payable and a debit to the applicable fixed asset account for the cost of the asset. The cost of an asset can include any associated freight charges, sales taxes, installation fees, testing fees, and so forth. There may be a number of fixed asset accounts, such as Buildings, Furniture and Fixtures, Land, Machinery and Equipment, Office Equipment, and Vehicles.
Step 2: Asset Depreciation
The amount of this asset is gradually reduced over time with ongoing depreciation entries. There are several variations on the depreciation calculation, but the most common approach is the straight-line method, where the estimated salvage value is subtracted from the cost, and the remaining amount is divided by the number of remaining months in the useful life of the asset. This yields a monthly depreciation charge, for which the entry is a debit to depreciation expense and a credit to accumulated depreciation. There are also several accelerated depreciation methods that recognize more of the depreciation early in the life of an asset. The balance in the accumulated depreciation account is paired with the amount in the fixed asset account, resulting in a reduced asset balance.
Step 3: Asset Impairment
The accountant should periodically test all major fixed assets for impairment. Impairment is present when an asset’s carrying amount is greater than its undiscounted future cash flows. When this is the case, record a loss in the amount of the difference, which reduces the carrying amount of the asset. If there is still some carrying value left, then this amount will still need to be depreciated, though probably at a much lower monthly rate than had previously been the case. Asset impairments are less likely towards the end of an asset’s useful life, because ongoing depreciation has reduced its carrying amount to a great extent.
Step 4: Asset Disposal
At the end of a fixed asset's useful life, it is sold off or scrapped. The entry is to debit the accumulated depreciation account for the amount of all depreciation charges to date and credit the fixed asset account to flush out the balance associated with that asset. If the asset was sold, then also debit the cash account for the amount of cash received. Any residual amount needed to balance this entry is then recorded as a gain or loss on sale of the asset.
Fixed Asset Accounting Best Practices
Here are several best practices to use when accounting for fixed assets:
Set a capitalization limit. Set a reasonably high capitalization limit, where only asset expenditures above this threshold are capitalized. All other expenditures are charged to expense at once. This approach reduces the number of fixed assets that you will have to track.
Standardize useful lives and depreciation methods. Use the same useful life and depreciation method for every asset assigned to a specific asset class. This makes it easier to calculate depreciation on your assets.
FAQs
Are Fixed Asset Records Required for Audits?
Fixed asset records are required for audits to verify the existence, accuracy, and ownership of assets. Auditors typically review the fixed asset register, acquisition documentation, and depreciation schedules. Accurate records help ensure proper financial reporting and compliance with accounting standards.
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