What are Fixed Assets?
Fixed assets are defined as assets that are used for business operations to generate income and are held for the long term. It is not expected to be converted into cash in the short term. Thus, these assets are not held for the purpose of immediate resale and are intended to benefit the organization for more than one reporting periodReporting PeriodA reporting period is a month, quarter, or year during which an organization's financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements.. Examples include plant and machinery, land and building, furniture, computer, copyright, and vehicles.
Types of Fixed Assets
There are two types – tangible and intangible assets.
#1 – Tangible Assets
Tangible assets are assets that have a physical presence and can be touched, such as land and building, plant and machinery, vehicles, etc. Generally, it is easier to value tangible assets as compared to intangible assets. Tangible assets are subject to depreciation, which is a reduction in the value of the asset over time.
#2 – Intangible Assets
Intangible AssetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. are assets that have no physical presence and cannot be touched. These include goodwill, trademarks, patents, software, licenses, other forms of intellectual property, etc. Amortization happens in the case of intangible assetsAmortization Happens In The Case Of Intangible AssetsAmortization of Intangible Assets refers to the method by which the cost of the company's various intangible assets (such as trademarks, goodwill, and patents) is expensed over a specific time period. This time frame is typically the expected life of the asset., which is the process of gradually writing off the initial cost of the asset.
List of Fixed Assets
- Computer Hardware
- Office Supplies
- Office Equipment like Printers, Chairs, etc
- Natural Resources
Fixed Assets in Accounting Example
Downey is thinking of starting a business nearby coastal of Gujarat. He starts a firm with the name of 3M and registers it with the relevant authorities. He purchases the below asset to start the firm by using the loan proceeds; you are required to account for the fixed assets in the books of account and discuss why they fall in each category.
Fixed assets are those assets that are purchased and held by the firm for more than one accounting period or more than 12 months period. Let’s test whether the above equipment passes the test?
Hence, the total cost to be accounted for will be 58,050,000 in books of account.
Fun and foods, a leading company that sells hamburgers, is now considering an expansion plan. It has considered Italy as the next country where it would like to establish its footprints. It also plans to set up an administrative team where they would require a computer, laptop, computer accessories, Cisco phones for those employees working for corporate. You are required to discuss whether these Cisco phones, computer accessories, computers, and laptops will fall within the definition of fixed assets?
The definition of fixed assets states that any asset that is purchased by the firm for more than one accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance. or administrative purposes or rental to others. In this case, we are not given any period of information. Still, however, it is mentioned that this equipment will be used for the administrative team, and hence the purposed will be for administrative purposes. It appears that this equipment will be used for more than one accounting period since its planning to expand business in Italy, and further, a new corporate office is also opened. From the above discussion, equipment will fall within the purview of fixed asset definition.
However, the computer accessories need to be scrutinized, whether the same are separable or inseparable assets as the accounting for the same is done differently. If they are inseparable, then they will be included in the cost to the computer, or if they are separable, then they will be recorded as a different asset in books of account.
Asha builders are on the verge of completing the construction of buildings at the remote site, which they started 5 years ago. However, those buildings are not ready to use, but 80% of the flats have been sold out. Asha, the owner of Asha builder, is unsure as to how she should account for buildings in her books of account as this was her new business. She has approached an accountant to help her decide the way these buildings cost and sell should be recorded in books of accounts.
Asha is into the field of a construction business, where the normal course of business is to sell the buildings at a price more than what it took to make and purchase the raw materials. Further, it took more than 5 years for them to complete the project. So, if we consider a definition of fixed assets, it states that an asset which is intended to use for more than one accounting period or more than 12 months or administrative purpose. Here, the first criteria are met where the assets were in possession for more than 5 years. So, whether this should be included?
Well, the answer to the above question is No. The reason is buildings on normal occasions take more time to complete, and it is a business of Asha builders to sell them, and they don’t intend to use it. So, these criteria of using those constructed buildings fail to meet and hence cannot be accounted as fixed assets in the books of accounts. Instead, the selling pricing less cost price and all the cost will be treated as normal income in the revenue statement, and the balance will be profit. However, one needs to follow what accounting standard on revenue states as to how to account revenue, cost, and profit; for example, there is a cost of completion method that one can use.
General motor transport services are in the business of transporting goods from one place to another. They owned 12 trucks, 6 small tempos, and 5 rented (on operating lease for 5 years) trucks. Discuss how these assets will be recorded in the books of account of general motor transport services, whether as fixed assets or will be recorded in revenue statements?
The criteria for recording assets as fixed assets that are purchased and:
- Intention to use for more than one accounting period or 12 months
- Use for administrative purposes.
Here, these vehicles are used by them, and since it’s their business and hence they would be using for more than one accounting period else they won’t be able to do business since replacing them every year will be too costly for them. Now the second thing here is the rest 5 trucks are rented (operating lease) and are not purchased by them, and hence those will not be recorded as fixed assets. However, 12 trucks and 6 small tempos will be recorded as fixed assets.
- It helps in generating income. For instance, in a manufacturing unit, goods are to be produced. Fixed assets in the form of machinery help in producing those goods. If goods are not produced, the business will not be able to sell those goods, and the purpose of the organization won’t be fulfilled. Similarly, such assets in the form of delivery trucks help in selling the goods.
- The depreciation on assets is spread over the useful life of the asset. Hence, the expense burden is spread over several years.
- Investors and creditors use information about assets to determine the financial health of a company. They then make decisions on whether to invest/lend also depending on the financial ratios calculatedFinancial Ratios CalculatedFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. from the financial statements.
- If an organization wants to take loans, assets can act as security for the loan. Thus, it enables a business to take loans.
- It assumes more importance in capital-intensive industries, such as manufacturing units.
- Generally, They are bulky. Hence, it is challenging to move many fixed assets like plant and machinery from one place to another.
- It can not be easily converted into cash. For instance, if a new car is bought, it would fetch generally lower than the purchase price immediately once it moves outside the car showroom. It generally takes a significant time to be disposed of. For instance, selling land requires numerous negotiations with buyers and a multitude of legal formalities.
- A big enterprise has thousands of assets. Tracking and recording them is a cumbersome process.
- Generally, It requires significant investment and cash outflows when they are purchased.
- When these assets are sold, profit/loss on sale is calculated and is recorded in the books of accounts.
- While preparing a cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities., a loss on the sale of assets is added to the net income to arrive at cash flow from operations (indirect method). Similarly, a profit on the sale of assets is deducted from income to get the cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital..
- Proceeds from the sale of assets and purchase of assets are treated as cash flows from investing activity Cash Flows From Investing ActivityCash flow from investing activities refer to the money acquired or spent on the purchase or disposal of the fixed assets (both tangible and intangible) for the business purpose. For instance, the purchase of land and joint venture investment is cash outflow, while equipment sale is a cash inflow..
- A change in the market value of fixed assets is accounted for through a revaluation of fixed assets. In such a case, a reliable market value estimate is needed.
They are one of the most critical components of a business. Managing fixed assets is essential as their purchase involves significant cash outflows. Since the disposal of assets is not an easy task, considerable planning is required to purchase assets. Decisions, once taken, cannot be easily reversed. An organization also needs a robust record-keeping system for accountingSystem For AccountingAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm. assets so that the decision-makers get vital information to make business decisions.
This article has been a guide to what is Fixed Assets and its definition. Here we discuss formula, top 2 types of fixed assets along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –