Accounting Definition of Fixed Asset
Fixed assets, also known as hard assets, include the long-term assets of a business that have a life expectancy of more than a year. The tangible fixed assets of a business include land and buildings, machinery and vehicles, while the intangible fixed assets include goodwill, patents and franchise rights. You record fixed assets on the balance sheet and reflect the overall worth of your business.
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Accounting for Fixed Assets
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Financial professionals use the accrual system to account for fixed assets. A fixed asset has a limited life, and you recognize the benefits that accrue from these assets over their useful life; therefore, fixed assets are not recorded at the time of purchase. The consumption that occurs over the life of the asset is depreciation. Using the matching principle of accounting, match the depreciated amount against the revenues generated by the fixed asset and deduct the depreciated amount as the expense incurred to generate that revenue.
Depreciation
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Depreciation is the decrease in value of fixed assets over time. This is true for most tangible fixed assets, except for real estate. Various formulas are available for depreciation calculations including the straight-line method and reducing-balance method. Method selection should depend on its favorability to your business. Depreciation calculations appear in the financial statements of the business, where you deduct the depreciated amount as an expense on the income statement and from the value of the fixed assets on the balance sheet.
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Cost of a Fixed Asset
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All costs can be traced back to the fixed asset. To record the value of a fixed asset and for depreciation calculations, include all expenses involved in the acquisition of the fixed asset in the cost figure. These costs include items such as delivery expenses, import duties incurred on transportation, installation fees and any architect's fees. The costs of major renovations are also capitalized while administrative costs or expenses involved in repair are not.
Economic Life
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Businesses use a fixed asset for as long as the fixed asset is economical. The asset may be in excellent physical condition after you repair wear and deterioration. The company, however, may find maintaining the fixed asset a liability due to other factors such as obsolescence and market demands. Estimate the economic life of a fixed asset based on the physical deterioration and additional factors and use your estimation for depreciated calculations.
Financial Ratios
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Managers, financial analysts and investors use financial ratios to judge company performance. Financial professionals use fixed assets in the calculation of asset utilization ratios such as a fixed asset turnover and total asset turnover. These ratios show how efficiently the company is using its assets to generate sales. Higher asset turnover ratios reflect greater company efficiency and are positive indicators to interested stakeholders, propeling greater investments and an increase in share value.
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References
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