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 period. Examples of fixed assets include plant and machinery, land and building, furniture, computer, copyright, and vehicles.
Types of Fixed Assets
There are two types of fixed assets – 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 Assets 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 assets, which is the process of gradually writing off the initial cost of the asset.
Fixed Assets Formula
Net fixed assets refer to the net book value of assets. It is calculated by subtracting the accumulated depreciation from the historical cost and improvement cost of the assets. The historical cost of assets is the purchase price of the assets. The formula is:
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Let’s see some examples of fixed assets to understand it better.
The historical cost of assets in $1000. Improvements worth $500 have been made. The accumulated depreciation on those assets is $300. Calculate the net fixed assets.
Calculation of Net Fixed Assets
= $1000 + $500 – $300
Net Fixed Assets = $1200
Albert Inc. is a quick service restaurant. The management decides to purchase furniture. On 1st April 2016, they purchased furniture worth $10,000. The useful life of the furniture is 9 years and its scrap value at the end of 9 years is $1,000. Calculate the book value of the furniture as on 31st March 2019. In addition, calculate the accumulated depreciation on the furniture for these 3 years up to 31st March 2019.
Calculation of Depreciation for Each Year
The formula to calculate depreciation for each year is
Depreciation for each year = ($10,000 – $1,000)/9
Depreciation for each year = $9,000/9
Depreciation for Each Year = $1,000
Calculation of Book Value
Book Value as on 31st March, 2017 = Purchase Price – Depreciation for the year
- = $10,000 – $1,000
- = $9,000
Book Value as on 31st March, 2018 = Book Value as on 31st March, 2017 – Depreciation for the year
- = $9,000 – $1,000
- = $8,000
Book Value as on 31st March, 2019 = Book Value as on 31st March, 2018 – Depreciation for the year
- = $8,000 – $1,000
- = $7,000
Accumulated Depreciation for 3 years = $1,000 + $1,000 + $1,000
Accumulated Depreciation for 3 Years = $3,000
Hence, the book value of furniture as on 31st March 2019 is $7,000. Accumulated Depreciation for 3 years is $3,000.
Please refer given excel template above for detail calculation
- 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, fixed assets in the form of delivery trucks help in selling the goods.
- The depreciation on fixed assets is spread over the useful life of the asset. Hence, the expense burden is spread over a number of years.
- Investors and creditors use information about fixed assets to determine the financial health of a company. They then take decisions on whether to invest/lend also depending on the financial ratios calculated from the financial statements.
- If an organization wants to take loans, fixed 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 very difficult 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 fixed 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 for in the books of accounts.
- While preparing a cash flow statement, a loss on the sale of assets is added to the net income in order 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 operations.
- Proceeds from the sale of assets and purchase of assets are treated as cash flows from investing activity.
- 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 important 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, significant planning is required to purchase fixed assets. Decisions once taken cannot be easily reversed. An organization also requires a robust record-keeping system for accounting fixed assets so that the decision makers get important information to take business decisions.
This 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 –