What Fixed Asset Accounting Has to Do in a Business?

Fixed assets, also known as tangible assets or property, plant, and equipment (PP&E), are vital to an organization’s financial health. Fixed asset accounting terms refer to assets and property not easily converted into cash. In a previous article, we discussed fixed assets, their types, and how they function. An equally important aspect is fixed asset accounting, which organizations must manage accurately to ensure a precise balance sheet at the end of the financial year.

Explanation of Fixed Assets and Fixed Asset Accounting

Fixed assets, also known as property, plant, and equipment (PP&E), are tangible assets held by an organization for the production and supply of goods and services, rentals, or administrative purposes. Unlike liquid assets, fixed assets include buildings, land, furniture, fixtures, machines, and vehicles, and are not intended for resale. For example, an organization selling cars will list cars for sale as inventory, whereas vehicles used for delivery or employee transportation will be classified as fixed assets.

Fixed assets are used for more than one accounting year, making them part of an organization's non-current assets. The benefits from fixed assets are derived over a long period.

Criteria for the Recognition of Fixed Assets

The basic criteria for recognizing fixed assets in an organization’s financial statements are:

• The inflow of economic benefits to the organization.
• Consistent cost measurement.

Valuation of Fixed Asset Accounting

Initial Valuation of Fixed Asset Accounting:

• Includes: Cost, incidental costs, duties, taxes paid for acquisition, site preparation, handling, and delivery costs.
• Excludes: Administrative costs, general overhead costs, and costs not directly related to bringing the asset to working condition.

Cost of an Asset for Fixed Asset Accounting:

• Purchase of Asset: Valuation includes all inclusions and exclusions.
• Purchase at Installment: Overall cost includes the market rate of interest.
• Exchange of Asset: Cost measured at fair value.

What is Fixed Asset Accounting?

Fixed asset accounting involves applying sound accounting standards to accurately represent long-term commodities on the bookkeeping records. A fixed asset has a useful life spanning multiple reporting periods and meets a certain capitalization limit.

Accounting Transactions to Record Fixed Assets

Initial Recordation

‍When an asset is purchased on credit, the initial entry is a credit to accounts payable and a debit to the applicable fixed asset account. The cost can include freight charges, sales taxes, installation, and testing fees. Examples of fixed assets include land, buildings, machinery, equipment, furniture, office equipment, and vehicles.

Depreciation‍

The asset's value decreases over time through continuous depreciation entries. The straight-line method is commonly used, subtracting the estimated salvage value from the cost and dividing the remaining amount by the number of months in the asset's useful life. The monthly depreciation entry is debited to depreciation expense and credited to accumulated depreciation. The balance in the accumulated depreciation account pairs with the fixed asset account to show a reduced asset balance.

Disposal

‍At the end of an asset's useful life, it is either sold or scrapped. The entry debits the accumulated depreciation account and credits the fixed asset account. If sold, the debit account reflects the cash received, with any remaining amount recorded as a gain or loss on the sale.

Disclosure:

Organizations must disclose various aspects of fixed assets in their financial statements, including:

• Initial value to determine the carrying amount.
• Method and rate of depreciation.
• Useful life of the asset.
• Accumulation of impairment loss and depreciation.
• Revaluation of reserve balance at the end of the financial year.
• Changes in the carrying amount value due to additions, disposals, or foreign exchange impacts.
• Revaluation changes.

Fixed Asset Turnover Ratio

A fixed asset turnover ratio measures an organization’s efficiency in using its fixed assets to produce income.

How to Represent Fixed Asset Accounting Correctly?

Fixed assets represent a significant capital investment, and accurate accounting is crucial. Here are some key points:

• Capitalization: Benefits extend beyond the purchase year, unlike other costs.
• Acquisition Cost: Includes all expenditures related to acquisition or construction, such as freight, sales tax, transportation, and installation.
• Capitalization Policy: Establish a minimum dollar amount, expensing assets below this value.
• Constructed Assets: Include all costs, such as materials, labor, overhead, and interest expense.
• Additions: Capitalize additions that increase the asset's service potential.

Do's and Don'ts of Fixed Asset Accounting

Do's:

• Consider all acquisition or construction costs.
• Adopt a capitalization policy.
• Estimate depreciation based on the asset’s useful life.
• Reevaluate useful life estimates continuously.
• Keep detailed depreciation records.
• Consider asset impairment for significant events or changes.
• Stay aware of new lease accounting standards.

Don'ts:

• Expense costs like sales tax or freight on fixed asset purchases.
• Use IRS depreciable lives for financial reporting.
• Ignore changes in asset use or service.
• Automatically depreciate a leased asset over its useful life without considering lease accounting.

Conclusion

Fixed asset accounting is essential for managing the assets used in production, rental, or administrative purposes. Accurate accounting ensures a precise balance sheet at the end of the financial year, enhancing business operations.

Incorporating optimized procurement software, purchase order software, purchase order systems, and purchase order management can further streamline and enhance fixed asset accounting practices.