Fixed assets are also known as tangible assets or property, plant, and equipment (PP&E). In terms of accounting, fixed asset accounting term is referred to assets and property which is not easily converted into cash.
We have discussed fixed assets in our previous article regarding:
What are the fixed assets? How fixed assets work? What are the types of fixed assets?
There is one more important factor related to this which is fixed asset accounting.
Where an organization needs to keep the accounts of its fixed assets in order to acquire an accurate balance sheet at the end of the financial year.
Table of contents
- Explanation of Fixed assets and Fixed Asset Accounting
- Criteria for the recognition of Fixed Assets
- Valuation of Fixed Asset Accounting
- 1. Initial Valuation of Fixed Asset Accounting
- 2. Cost of an Asset for Fixed Asset Accounting
- What is Fixed Assets Accounting?
- Accounting Transactions to record for Fixed Assets
- Initial Recordation:
- What is Fixed Asset Turn Over Ratio?
- How to represent Fixed Asset Accounting correctly?
- Facts and insights to be touch with:
- Do's and Don'ts to remember while Fixed Asset Accounting
Explanation of Fixed assets and Fixed Asset Accounting
Fixed assets are also known as property, plant, and equipment (PP&E) which are tangible assets that are held by an organization for the production and supply of goods and services or for rentals to others or for administrative purposes.
These fixed assets are not liquid assets in general, they incorporate buildings, land, furniture and fixtures, machines and vehicles. These fixed assets are not held for resale purposes but for production, supply, rental, and administrative purposes.
Assets that are held for resale must be accounted for as inventory rather than a fixed asset. For instance, an organization that deals with selling cars will not account cars for sales as a fixed asset but as inventory, whereas any vehicle other than the purpose of resale will be classified as a fixed asset like delivery trucks and employee cars.
Fixed assets are expected to be used for more than one accounting year making them part of the non-current type of assets for an organization. Therefore, benefits from fixed assets are derived in a long time.
Criteria for the recognition of Fixed Assets
The basic criteria for the recognition of fixed assets in the financial statements of an organization are:
- The inflow of economic benefits to the organization
- Cost measured consistently
Valuation of Fixed Asset Accounting
1. Initial Valuation of Fixed Asset Accounting:
- Initial Cost of an Asset Includes - Cost, Incidental Costs, Duties, Taxes Paid pertaining to Acquisition, Preparation of the site, Handling and Delivery Cost of the Asset, etc.
- Initial Cost of an Asset Excludes - Administrative Costs, General Overhead Costs, Costs that don't directly relate to bringing the asset to its working condition.
2. Cost of an Asset for Fixed Asset Accounting:
- Purchase of Asset - At the purchase of any asset, its valuation will be after considering all inclusions and exclusions.
- Purchase at Installment - The overall cost of an asset should include the market rate of the interest cost.
- Exchange of Asset - The cost of the asset should be measured at fair value.
What is Fixed Assets Accounting?
When an organization is concerned with the trading of fixed assets, sound accounting standards should fill in as a standard to perfectly analyze the representation of long cargo commodities on the bookkeeping records.
A fixed asset can be any item that has a useful life that spans multiple reporting periods and its cost could increase its certain minimum limit known as capitalization limit.
Accounting Transactions to record for Fixed Assets
On the belief that the asset is purchased on credit, the initial entry will be 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 - freight charges, sales taxes, installation fees, testing fees, etc. The examples of fixed assets are:
- Machinery and Equipment
- Furniture and Fixtures
- Office Equipment
The amount of the asset is slowly decreased over time with continuous depreciation entries. There are various variants in depreciation calculation, but the mostly straight-line method is used where the estimated salvage value is subtracted from the cost and the remaining amount is divided by the number of remaining months within the useful life of the asset.
This will tell the monthly depreciation value, for which the entry is debited to depreciation expense and credited to accumulated depreciation.
The balance amount in the accumulated depreciation account is now paired with the amount in fixed asset account to result it in a reduced asset balance.
At the end of fixed asset's useful life either it is sold off or scrapped. The entry is for debiting the depreciation amount from accumulated depreciation account, that too to date and credit the fixed asset account to plentiful the balance associated with that asset.
In case the asset is sold off, then also the debit account should be debited with the amount of cash received.
Any kind of remaining amount that will be needed to balance the entry will then be recorded as a gain or loss on the sale of cash.
There are few disclosures that are related to fixed assets in the financial statement of an organization.
- Initial Value of an asset to determine the carrying amount.
- Method of Depreciation adopted.
- Rate of Depreciation.
- The useful life of the asset.
- Accumulation impairment loss and depreciation.
- Revaluation of reserve balance at the end of every financial year.
- Changes in the value of carrying amount (due to any addition or subtraction during the financial year). Also, it should include acquisitions, disposals, the impact of net foreign exchange on the value of the asset.
- A must disclosure to any kind of change in the value of an asset (due to revaluation).
What is Fixed Asset Turn Over Ratio?
A fixed asset turnover ratio is an activity proportion that measures the efficiency of an organization to use its fixed assets and resources in producing income.
How to represent Fixed Asset Accounting correctly?
For almost all businesses fixed assets represent a significant capital investment, therefore, it is important to account for these fixed assets correctly.
Facts and insights to be touch with:
- Fixed assets are capitalized therefore, the benefit of these assets tends to increase for more than the year of purchase, unlike the other costs, which benefits only in the period experienced.
- Fixed assets should be recorded at the cost of acquisition. This cost will include all expenditures that are related to the acquisition or construction, including costs as freight, sales tax, transportation, and installation should be capitalized.
- All the businesses should adopt a capitalization policy that will establish a minimum dollar amount. Fixed assets that cost less than this value should be expensed.
- If the assets are constructed by the organization, they should include all components of cost, including materials, labor, overhead, and interest expense, if applicable.
- The additions that are made will increase the service potential of the asset, and so they should be capitalized.
Do's and Don'ts to remember while Fixed Asset Accounting
- Consider all costs at the time of acquisition or construction.
- Adopt a capitalization policy.
- Estimate a useful life for depreciation based on an asset's useful life.
- Consider whether the asset will have value at the end of its useful life, then build the depreciation on cost, less estimated salvage value.
- Reevaluate estimates of useful lives on a continuous basis.
- Keep the depreciation records in enough detail so assets can be accurately tracked when physically moved or disposed of.
- Consider asset impairment when significant events or changes in circumstances occur.
- Be aware of changes forthcoming with new lease accounting standards.
- Expense costs such as sales tax or freight incurred on a fixed asset purchase.
- Use of depreciable lives based on Internal Revenue Service rules for financial reporting purposes.
- Ignore changes in an asset's use or service or consider asset impairment.
- Automatically depreciate a leased asset over its useful life and consider lease accounting to determine proper life.
Fixed asset accounting is accounting for fixed assets. In this accounting, the fixed assets are purchased for the supply of services and goods which will further be used in production, rental let out or/and administrative purposes.
Therefore, the organization is in need to keep the accounts of its fixed assets in order to acquire the accurate balance sheet at the end of the financial year for the enhancement of your business.