Assets are items of value owned by a company. They are shown on its balance sheet. Most financial statements will break down asset holdings into fixed assets, non-current assets, or current assets depending on their specific characteristics.
What are fixed assets?
Fixed assets are long-term assets that a company has purchased and is using for the production of its goods and services.
Fixed assets are noncurrent assets, meaning the assets have a useful life of more than one year. Fixed assets include property, plant, and equipment (PP&E) and are recorded on the balance sheet. Fixed assets are also referred to as tangible assets, meaning they’re physical assets.
While(International Accounting Standard) does not define the term “Fixed Asset”, it is often colloquially considered a synonym for property, plant, and equipment. According to IAS 16.6, property, plant, and equipment are tangible items that:
- Are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes and
- Are expected to be used during more than one period.”
Fixed assets are one of two types:
- “Freehold Assets” – assets which are purchased with legal right of ownership and used, and
- “Leasehold Assets” – assets used by owner without legal right for a particular period of time.
A fixed asset can also be defined as an asset not directly sold to a firm’s consumers or end-users.
Key Characteristics of a Fixed Asset
The key characteristics of a fixed asset are listed below:
- They have a useful life of more than one year. Fixed assets are non-current assets that have a useful life of more than one year and appear on a company’s balance sheet as property, plant, and equipment (PP&E).
- They can be depreciated. With the exception of land, fixed assets are depreciated to reflect the wear and tear of using the fixed asset.
- They are used in business operations and provide a long-term financial benefit. Fixed assets are used by the company to produce goods and services and generate revenue. They are not sold to customers or held for investment purposes.
- They are illiquid. Fixed assets are non-current assets on a company’s balance sheet and cannot be easily converted into cash.
Examples of Fixed Assets
- Buildings and facilities
- Vehicles (company cars, trucks, forklifts, etc.)
- Computer equipment
Although the list above consists of examples of fixed assets, they aren’t necessarily universal to all companies. In other words, what is a fixed asset to one company that may not be considered a fixed asset to another?
In business, fixed assets are often called “property, plant, and equipment” (PP&E). That is because most fixed assets are items that have been bought to serve a business purpose. Typical examples of PP&E include land, buildings, vehicles, machinery, and IT equipment.
Such items are clearly significant purchases. Fixed assets generally are higher-value items. In simple terms, there is generally a strong link between the price of an item and how long it is expected to last. But it’s important to note that the definition of a fixed asset hinges on its expected lifespan rather than its price.
For example, say a jeweler bought an ergonomic mouse and a batch of diamonds. The mouse is clearly the lower-priced purchase, but the jeweler expects it to last at least two years. It is therefore a fixed asset. By contrast, the jeweler expects to use the diamonds in a commission they need to complete within a month. The diamonds, therefore, are current assets.
How Fixed Assets Work?
As far as accounting concepts go, fixed assets are relatively simple. Farmers need tractors, landscapers need trucks, and as discussed above, restaurants need ovens. Most businesses, regardless of size, require some amount of Property, Plant, and Equipment to operate.
Where it becomes slightly more complicated, however, is when it comes to recording the value of the fixed asset on the balance sheet and when accounting for depreciation over the course of its life.
There are some loan products and lines of credit that allow you to borrow against fixed assets as collateral. These can be helpful for smaller businesses whose cash flow might not be enough to support traditional loan approval.
A business can choose to capitalize a purchase of Property, Plant, and Equipment by recording the items as a fixed asset and deducting a portion of their price over the length of their life. Capitalizing means that the item is recorded as a long-term asset, rather than an expense. According to generally accepted accounting principles, known as GAAP, in order for an item to be capitalized, it must be owned by the business and have a useful life of more than one year.
In the case of the restaurant owner, once they’ve chosen the oven they’d like to use in their business, rather than marking it as an expense, they would capitalize it by recording it as a fixed asset.
They would record the oven’s cost, which includes the purchase price along with any cost associated with moving or installing the oven. Then, once the item is installed and in service, the restaurant owner can begin to record depreciation.
Depreciation accounts for the normal wear and tear that an item undergoes during the ordinary course of business, and it is spread out over the course of an item’s life. It begins one month after a fixed asset is placed into service and continues until an item is fully depreciated or disposed of either through salvage or sale.
Depreciation is deducted from gross profit on the income statement, thereby reducing gross taxable income for the business.
Importance and benefits of fixed assets
- Information about an organization’s assets will help you acquire accurate financial reporting, business valuations, and thorough financial analysis.
- An organization uses these reports and balance sheets to record, depreciate, dispose of assets and the analysts use them to study on corporation’s financial; statements.
- A clarified representation of organizational capital sum to the followed financial profit and evaluation of business concerns.
- Information on fixed assets and their depreciation is additionally used by financial experts to report down whether the organization id profitable or non-profitable enterprise.
- Ascertainment of profitability of the fixed asset, the plan of action for depreciation has to be inspected.