This article is about what are fixed assets. If you run a business, you may have heard of the term "fixed assets". Fixed assets are long-term tangible assets that are used in the normal operations of a business. They are not intended for sale or conversion into cash within a year.
What are Fixed Assets?
Fixed assets are long-term tangible assets that are used in the normal operations of a business. They are not intended for sale or conversion into cash within a year. Examples of fixed assets include land, buildings, machinery, equipment, vehicles, furniture, and fixtures. Fixed assets are also called property, plant, and equipment (PP&E) or capital assets.
Fixed assets are different from current assets, which are short-term assets that can be easily converted into cash or consumed within a year. Examples of current assets include cash, accounts receivable, inventory, and prepaid expenses. Current assets are also called working capital.
Fixed assets are important for a business because they represent the long-term investments that the business has made to acquire the resources it needs to operate and generate income. Fixed assets also affect the balance sheet, the income statement, and the cash flow statement of a business.
How to Classify and Record a Fixed Asset?
To classify a fixed asset, you need to consider its useful life and its physical substance. The useful life of a fixed asset is the estimated period of time that the asset will provide economic benefits to the business. The physical substance of a fixed asset is the material form of the asset, whether it is tangible or intangible. Tangible assets have a physical existence and can be seen and touched. Intangible assets have no physical existence and can only be identified by legal rights or other evidence. Examples of intangible assets include patents, trademarks, goodwill, and copyrights.
To record a fixed asset, you need to determine its cost and its depreciation method. The cost of a fixed asset is the amount of cash or cash equivalents paid to acquire the asset or its fair value at the time of acquisition. The cost of a fixed asset includes all the necessary expenditures to bring the asset to its intended condition and location for use. Examples of such expenditures include purchase price, transportation costs, installation costs, taxes, and legal fees. The cost of a fixed asset does not include any financing charges or interest expenses.
What is the Depreciation of a Fixed Asset?
The depreciation of a fixed asset is the systematic allocation of its cost over its useful life as an expense in each accounting period. Depreciation reflects the wear and tear or obsolescence of the asset over time. Depreciation also reduces the carrying value of the asset on the balance sheet. The carrying value of a fixed asset is its cost minus its accumulated depreciation. The accumulated depreciation of a fixed asset is the total amount of depreciation that has been charged to the asset since its acquisition.
There are different methods of depreciating a fixed asset, such as straight-line method, declining balance method, units of production method, and sum-of-the-years' digits method. Each method has its own advantages and disadvantages depending on the nature and usage of the asset. The choice of depreciation method affects the amount of depreciation expense in each period and the carrying value of the asset over time.
Bottom Line
In this article, we have discussed what are fixed assets. To classify, record, and depreciate a fixed asset, you need to consider its useful life, its physical substance, its cost, and its depreciation method.
