A Lean System for Fixed Assets (#139)
/In this podcast episode, we discuss several best practices that are designed to reduce the accounting work related to fixed assets. Key points made are noted below.
The Problems with Fixed Assets
As I’ve been pointing out in the last couple of episodes, we’re assuming that “lean” means doing accounting with minimal resources. That’s pretty tough to do with fixed assets. Consider all of the accounting you have to do. There’s setting up a depreciation calculation, and the related journal entry, and doing a fixed asset roll forward to make sure that you didn’t screw up anywhere. And when you eventually dispose of the asset, there’s a disposal transaction to figure out, maybe with some gains or losses. And on top of that, you have to review the larger items for impairment. And there may be asset retirement obligations to keep track of. And, if you’re using international financial reporting standards, you may be revaluing the assets up or down. Two problems with all of this. First, it’s a lot of work. And second, if you want to be in compliance with the accounting standards, then you have to do all of it. From the perspective of introducing lean concepts, it initially looks like you’re completely screwed.
Lean Suggestions for Fixed Assets
But that’s not quite true. Let’s look at this from the perspective of how much each fixed asset costs. If you make a list of all your fixed assets and sort them by cost, the result is going to look like a pyramid. There’ll be a couple of really expensive assets at the top of the pyramid, and there’ll be a whole pile of low-cost ones across the base of the pyramid.
Since we can’t eliminate any of the accounting work associated with fixed assets, the next best thing to do is to get rid of the assets – in particular, the ones along the base of the pyramid.
There’re two ways to do this, and you should go after both of them. First, the threshold at which you call something a fixed asset instead of an expense is called the capitalization limit, or the cap limit. You want to reset the cap limit so that it excludes all of the lowest-cost fixed assets. For example, if you’ve been capitalizing laptop computers, stop that right now. Those are office supplies. Seriously. Just taking this one step will wipe out a huge chunk of your fixed assets. Yes, it will increase the amount you charge to expense in the short term, but it’s just not that much money.
The second lean improvement involves something called base unit aggregation. A base unit is a company’s definition of what constitutes a fixed asset. So if you’re constructing a building, a lot of invoices go into a single fixed asset item. That’s fine. The problem is when you aggregate a lot of low cost items into a fixed asset that’s barely above the cap limit in total. For example, you could have a fixed asset called a group of desks. Each of those desks would normally have been charged to expense. Because you aggregated them, the group is a fixed asset. That’s bad.
What you should do is disaggregate those desks, which means you record them individually. Then they fall below the cap limit, and you won’t have to record them as fixed assets. And that gives you a more lean accounting department.
And for that matter, how do you track a group of desks? They’re going to be in different rooms, and they’re going to keep getting moved around over time. You won’t even know if they’re gone. It’s just not logical to use aggregation.
Those are my two main improvement areas for lean fixed assets. But there are some other possibilities, and they all involve doing the simplest possible accounting. If you keep it simple, there’s less room for error, and that means it’s easier to reconcile the accounting records.
First, only use one depreciation method, and make that method the straight-line method. It’s the simplest one, it’s really hard to screw up, so why not? Most of the accelerated depreciation methods are just the reverse – it’s kind of unusual not to make a mistake.
Second, don’t bother adding salvage value to the depreciation calculation unless you’re dead certain there’s going to be a salvage value, and it’s going to be material. Otherwise, you’re just going to complicate the depreciation calculations, that means it’s easier to screw up.
Next, avoid interest capitalization like the plague. It’s complicated to calculate the amount.
So if you’re only constructing an asset for a short period of time, do everything you can – legally – to avoid capitalizing any interest expense.
And finally, there’s asset classes, like computer equipment and furniture & fixtures. A lot of companies assign a standard useful life and depreciation method to all of the assets within each asset class. The trouble is that if you every move something from one class to another, you may have to change the useful life and the depreciation method. Which gets complicated.
My recommendation is pretty obvious. Just keep it simple. You should use the absolute minimum number of asset classes that you can get away with, since that way, you don’t need to worry about putting something in the wrong asset class, and then having to readjust the depreciation or the useful life to match the asset class that you should have put it into.
So what have lean concepts done for us? You should have far fewer fixed assets to track, and you should have standardized the accounting for those fixed assets that are left.
There’ll still be a few really expensive assets that require the full range of fixed asset accounting, with impairment analysis and asset retirement obligations, but those are going to be the exception. Most of the other assets won’t even be there anymore.