- What is a fixed asset?
- What are some fixed asset types?
- What is fixed asset accounting?
- International Financial Reporting Standards: An overview
- What records should I keep for fixed asset accounting?
- Best practices for fixed asset accounting:
WHAT IS A FIXED ASSET?
Companies acquire fixed assets as long-term tangible property. These assets are used in daily business operations to generate income for the business. Often referred to as the ‘capital’ of the business, they include items such as machinery and plant equipment. Their defining feature is that they are not converted into cash in the first year of acquisition. Firms tend to invest in fixed assets for the following objectives:
- To enable the production or supply of business goods and services
- To act as rentals for third parties
- To be used in regular organizational workflows
People often ask how fixed assets are different from inventory. Business inventory is defined as any current asset in the financial database of your organization. Goods classified as inventory signify the company’s worth and can be easily cashed out to cover up any existing debts. For simplicity, inventory can be divided into four categories:
- Raw materials needed for manufacturing items
- Goods and services in progress
- Finished goods
- Maintenance, repair and operating supplies
As you can see, this is completely different from a fixed asset, which is often a finite, long-term investment. Another point that must be clarified is that fixed assets don’t have to be ‘fixed’ in the sense of being stationary or immobile. They can easily be moved around from one location to another, with vehicles and computer equipment being good examples of this.
The best way to dispose a fixed asset is to sell it at its salvage value. Companies have different ways to determine this, depending on the frequency of use, item type, and deprecation rate. In addition to this, procurement patterns for these assets can be quite complex, as they tend to be quite costly and have high lead times. Keeping accurate records on your fixed assets therefore allows you to build credibility for investment and loan opportunities, and helps you make the most our of your business investments.
WHAT ARE SOME FIXED ASSET TYPES?
In order to ensure streamlined management processes, organizations invest in a few common types of fixed assets. Without these, a company may not be able to function at optimal levels. Here are examples of some fixed asset every business owns in order to increase efficiency and employee productivity:
A) Computer equipment:
In this age of the cloud and online data reserves, it is quite challenging to work without sophisticated computer equipment. This is why every department in every business likely has its own computers allocated to respective employees. The stratification of fixed assets lowers the chances of misplacement and theft, and makes it easier to get tasks done on time. If you are one of the millions of business who use management software, access to laptops will make it easier for your employees to view relevant updates and work assignments.
B) Furniture and fixtures:
Every office building comprises of furniture and fixtures. These could either be movable items without any permanent connection to the structure – such as desks – or utilities affixed to the buildings – such as lights. These types of fixed assets play a fundamental role in ensuring seamless daily tasks. These are the kinds of things you don’t notice when all is well, but can really cause disruptions when they break down!
The type of machinery and equipment used by a company depends on its particular industry.For example, a construction firm could have numerous trailers and cranes. Tools and instruments would facilitate technical work and help achieve operational efficacy. To keep machinery in good shape, organizations must implement robust maintenance sessions on a regular basis.
Due to a rise in business mobility and functional diversity, businesses tend to allocate separate budgets for specific vehicles. Depending on the nature of work, companies opt for various types of vehicles suited to their job stature. For firms working on off-site projects, large trucks for conveyance can be a good choice, whereas small cars for short travel prove to be cost effective.
WHAT IS FIXED ASSET ACCOUNTING?
Fixed asset accounting relates to the accurate logging of financial data as it pertains to fixed assets. For this, companies require details on a fixed asset’s procurement, depreciation, audits, disposal, and more.
Since fixed assets form a substantial part of a company’s investments, it is imperative to record their specifications and activities in the correct manner. As per financial processes, fixed assets are listed under cash flow statements (or sometimes under the investments). This is why in general accounting terms, a purchased fixed asset is a cash inflow, while one that is sold is considered a cash outflow.
So how are fixed assets valued? Due to ongoing usage, fixed assets are subject to constant devaluation, and as a result they decline in value every year. A fixed asset therefore appears in accounting books at its net value, which is its original cost depreciated according to a specific rate over the years.
The following transactions should be carried out when you add fixed assets to your financial records:
- Periodic depreciation (applicable to tangible assets)
- Amortization (applicable to intangible assets)
After the completion of the useful life of an asset, recording disposal is as important as entering in a new purchase. In addition, for reliable accounting procedures, it is always best to calculate specific depreciation rates for all your fixed assets. Now that we have a general idea of the activities involved in fixed asset accounting, let’s take a look at a set of standards crucial for the smooth functioning of your fixed asset accounts.
INTERNATIONAL FINANCIAL REPORTING STANDARDS: AN OVERVIEW
Companies adopt universal processes to ensure comparability with reference to their end of year accounting reports. For fixed asset accounting, the International Financial Reporting Standards (IFRS) is a framework which provides uniform guidelines to prepare and organize financial data. Actively endorsed by more than 120 countries worldwide, the IFRS has been derived from the International Accounting Standards Board based in London. So, what value does this add for businesses?
Companies across the world are likely to have different asset management structures, which is why they would document usage through various methods. To cut across such variations, the IRFS brings forth consistent rules and regulations for countries to follow. If your company lacks a robust accounting process, it is likely to suffer in the long run. For this reason, the IFRS encourages firms to acquire a set of authorized accounting directives to control for errors, negligence, and fraudulent activities.
Using these standards allows organizations to design and execute sophisticated management strategies for various processes such as:
- Documentation of financial records
- Revenue calculation
- Employee welfare practices
- Fixed asset valuation
- Income tax regulation compliance
Therefore, choosing a universally accepted mechanism like the IRFS works in favor of all companies. It makes it easier to report statistics without having to undergo costly conversions according to acceptable standards. If you want to compete within international markets, it is best to opt for a financial structure that allows you to do so easily.
Universal accounting standards lower costs and improve comparability.
WHAT RECORDS SHOULD I KEEP FOR FIXED ASSET ACCOUNTING?
As soon as you acquire a new asset, you should add certain details to your financial reports as well. Doing this lets you maintain an updated database from purchase to disposal. To get you started, here are a few major fixed asset record keeping procedures you should familiarize yourself with:
This refers to the initial acquisition of any type of fixed asset your business buys. For convenience purposes, we assume that assets are obtained on credit. Following simple accounting methods, the first entry is a credit under the account payable section, and a debit to the specific fixed asset account equal to the cost of the asset. This cost can also include any other overheads incurred, including freight charges, sales tax, installation charges, and so on. You can generate a number of fixed asset accounts to accommodate equipment, machinery, land and vehicles.
Any sort of tool or machine is subject to wear and tear over time. This process is called depreciation and needs to be monitored in financial records as well. The journal entry for devaluation can be a single one or divided into different sections depending on the number of your fixed assets. You record this as a credit to the accumulated depreciation account and a debit to the depreciation expense account. Over the years, the accumulated depreciation balance will continue to increase in value until it equals the total cost of the fixed asset. At this stage you can stop accounting for depreciation and formally retire the asset.
The next stage in fixed asset accounting is to assess the impairment loss to your equipment. Impairment usually concerns any sudden loss or damage to the assets due to unexpected circumstances. Organizations faced with this situation have to document this change in their financial statements as well. In order to calculate impairment loss, it is important to know these terms:
- Carrying amount: This is the total cost of the asset less its accumulated depreciation.
- Recoverable amount: This amount relates to the benefits that can be obtained from a fixed asset. It equals to the greater of fair value minus costs to sell, and the value in use.
- Fair value minus costs to sell: We can calculate this by subtracting costs which will be incurred from selling this asset from its current market value.
- Value in use: This is the amount of the present value for cash inflows that are derived from the asset under a specific scenario.
Once you have received the carrying amount, you have to compare it with the recoverable amount. If the carrying amount is greater than recoverable amount, you can credit the accumulated impairment and debit the impairment loss.
As soon as an asset completes its lifecycle, you have to eliminate it from your financial documents as well. This process involves the reversal of the accumulated depreciation and fixed cost accounts. Whatever difference remains is recognized as a loss or a gain. You can log the gain or loss by subtracting the carrying value from the net disposal proceeds. The simple entry is a debit to the accumulated depreciation account and a credit to the asset account.
An audit is mainly the examination of the company’s financial records. Firms carry out this activity to establish credibility and reliability within the market, and to promote transparency within their organization itself. When it comes to fixed asset accounting, audits allow companies to supervise usage patterns and stop any unauthorized practices. In order to carry out fixed asset auditing, auditors tend to observe or recalculate the following business records:
- Purchase and disposal authorizations
- Lease documentation
- Appraisal reports
- Accumulated depreciation or amortization amounts.
Audits tend to check the accuracy of financial reports and validate transactions along the way. Depreciation discount rates are also passed through a valuation test to ensure the correct processes have been followed. Lastly, audits tend to examine the classification of fixed assets as well.
BEST PRACTICES FOR FIXED ASSET ACCOUNTING
Accounting for assets is a crucial task for firms and needs to be carried out with a lot of care. A single error in the financial reports can lead to grave consequences and damage the integrity of a company’s records. The best way to go about this is by observing the best practices we have laid out below:
Establish a threshold for capitalization: The first step towards maintaining error-free accounts involves setting a criterion to distinguish assets from expense items. Items which are to be used for more than one year are more accurately recorded as assets. Doing so comes in particularly handy as it also lets you differentiate between different accounts, and save yourself from material misstatement in your financial reports.
Ensure your assets have tags: Quite a few companies have fixed assets that are transported across locations for off-site projects. This may become difficult to track, and can result in huge losses as a result of theft and misplacement. To control such unwarranted activities, it is critical to tag your assets. Barcode and QR Code labels can be a good option for easy check-ins and checkouts. Tags let you supervise movements at various locations for data transparency, and allow you to have better data for your financial reports.
Automate your insights: These days, a huge number of companies resort to cloud based accounting software in order to carry out efficient fixed asset accounting. Other software, such as an asset tracking solution, can offer a variety of features to track asset usage from the time of purchase to disposal. Real time electronic records such as these reduce human error and let you maintain an accurate database which can be updated from anywhere, and at any time.
Choose the right depreciation method: Most companies fail to come up with the correct depreciation method for their assets. Due to the lack of vigilance around fixed asset accounting, businesses can sometimes end up with erroneous data. To avoid such scenarios, it is recommended that you classify your assets according to their use, durability, and expected life. You should then determine the best possible depreciation method based on the attributes of these distinct groups. What works for a group of laptops, for example, won’t necessarily be the best option for heavy plant equipment.
Get insured and record it: As fixed assets are to be used for more than one year, getting insurance is a good idea. The appropriate insurance coverage allows you to tackle unexpected damages to your assets. However, whenever you do apply insurance claims, be sure to record them against their respective accounts as well. Carrying out this practice means that you properly state the damage and how it was compensated for. A true representation of asset usage in this way will prove to be extremely beneficial for the firm’s credibility.
Fixed asset accounting is an intricate process which requires a lot of attention to detail. In order to maintain precise financial reports, firms should oversee work processes which involve the use of fixed assets, and be diligent in the way they capture important data relating to these items. Success in maintaining reliable accounting reports can help firms exercise robust preventative maintenance, improve productivity, and deter theft across your organization.
This article was written with thousands of EZOfficeInventory business customers in mind. We’re a fixed asset tracking software that enables companies to manage their fixed assets on job sites, plants, and factories across the globe. With label tracking, a fully-featured mobile app, and sophisticated maintenance and depreciation modules, EZOfficeInventory has helped companies improve ROIs across the board. You can sign up for a free trial to see what we’re all about.