Fixed asset accounting
/What is a Fixed Asset?
A fixed asset is an item having a useful life that spans multiple reporting periods, and whose cost exceeds a certain minimum limit (called the capitalization limit). It is classified as a long-term asset, since it will remain on your books for an extended period of time. In a capital-intensive business, fixed assets may very well be the largest asset class on an organization’s balance sheet.
How to Account for Fixed Assets
There are several accounting transactions to record for fixed assets, which are noted below. Some of these transactions will need to be repeated several times over the useful life of an asset.
Step 1: Initial Asset Recordation
On the assumption that the asset was purchased on credit, the initial entry is 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 any associated freight charges, sales taxes, installation fees, testing fees, and so forth. There may be a number of fixed asset accounts, such as Buildings, Furniture and Fixtures, Land, Machinery and Equipment, Office Equipment, and Vehicles.
Step 2: Asset Depreciation
The amount of this asset is gradually reduced over time with ongoing depreciation entries. There are several variations on the depreciation calculation, but the most common approach is the straight-line method, where the estimated salvage value is subtracted from the cost, and the remaining amount is divided by the number of remaining months in the useful life of the asset. This yields a monthly depreciation charge, for which the entry is a debit to depreciation expense and a credit to accumulated depreciation. There are also several accelerated depreciation methods that recognize more of the depreciation early in the life of an asset. The balance in the accumulated depreciation account is paired with the amount in the fixed asset account, resulting in a reduced asset balance.
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Step 3: Asset Impairment
The accountant should periodically test all major fixed assets for impairment. Impairment is present when an asset’s carrying amount is greater than its undiscounted future cash flows. When this is the case, record a loss in the amount of the difference, which reduces the carrying amount of the asset. If there is still some carrying value left, then this amount will still need to be depreciated, though probably at a much lower monthly rate than had previously been the case. Asset impairments are less likely towards the end of an asset’s useful life, because ongoing depreciation has reduced its carrying amount to a great extent.
Step 4: Asset Disposal
At the end of a fixed asset's useful life, it is sold off or scrapped. The entry is to debit the accumulated depreciation account for the amount of all depreciation charges to date and credit the fixed asset account to flush out the balance associated with that asset. If the asset was sold, then also debit the cash account for the amount of cash received. Any residual amount needed to balance this entry is then recorded as a gain or loss on sale of the asset.
Fixed Asset Accounting Best Practices
Here are several best practices to use when accounting for fixed assets:
Set a capitalization limit. Set a reasonably high capitalization limit, where only asset expenditures above this threshold are capitalized. All other expenditures are charged to expense at once. This approach reduces the number of fixed assets that you will have to track.
Standardize useful lives and depreciation methods. Use the same useful life and depreciation method for every asset assigned to a specific asset class. This makes it easier to calculate depreciation on your assets.
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