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Fixed assets are also called Property, Plant, and Equipment, are assets with relatively long useful lives that a company is currently using in operating the business. This category includes land, buildings, machinery and equipment, delivery equipment, and furniture. Depreciation is the practice of allocating the cost of assets to a number of years. Companies do this by systematically assigning a portion of an asset’s cost as an expense each year (rather than expensing the full purchase price in the year of purchase). The assets that the company depreciates are reported on the balance sheet at cost less accumulated depreciation. The accumulated depreciation account shows the total amount of depreciation that the company has expensed thus far in the asset’s life.
Plant assets are resources that have three characteristics:
- They are also called property, plant, and equipment; plant and equipment; and fixed assets.
- They have a physical substance (a definite size and shape), are used in the operations of a business, and are not intended for sale to customers.
- These assets are expected to provide services to the company for a number of years.
Because plant assets play a key role in ongoing operations, companies keep plant assets in good operating condition. They also replace worn-out or outdated plant assets, and expand productive resources as needed. Many companies have substantial investments in plant assets.
Determining the Cost of Fixed Assets
The cost principle requires that companies record plant assets at cost. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. For example, the cost of factory machinery includes, the purchase price, freight costs paid by the purchaser, and installation costs. Once cost is established, the company uses that amount as the basis of accounting for the plant asset over its useful life.
Companies often use land as a building site for a manufacturing plant or office site. The cost of land includes:
(1) The cash purchase price,
(2) Closing costs such as title and attorney’s fees,
(3) Real estate brokers’ commissions, and
(4) Accrued property taxes and other liens assumed by the purchaser.
For example, if the cash price is Rs. 50,000 and the purchaser agrees to pay accrued taxes of Rs. 5,000, the cost of the land is Rs. 55,000. Companies record as debits (increases) to the Land account all necessary costs incurred to make land ready for its intended use.
Features of Fixed Assets
Three common traits of these fixed assets are that they are used in the operation of the business, they last more than one year, and they usually are fairly expensive. These assets are recorded at cost. All the amounts necessary to get the asset ready for use are included as part of the cost. These amounts commonly include the cost of the item, sales tax, and delivery and installation costs.
There will be separate fixed-asset accounts for land, land improvements, leasehold improvements, buildings, equipment, machinery, furniture, fixtures, and vehicles. Some companies choose to combine some of these accounts, using accounts such as machinery and equipment or furniture and fixtures. The initial one-time payments related to the purchase of the asset are part of its cost. Ongoing payments for maintaining and operating the asset are not part of its cost.
>>> Read accounting for Depreciation.
Journal Entry of Fixed Assets
Let’s take the acquisition of vehicle. Here is the information pertaining to the purchase price agreed to with the dealer:
Vehicle cost Rs. 500,000, Taxes 24,500, Title 5,000, Dealer prep 17,000:
The entry to record the acquisition of the vehicle (assuming that cash was paid) is:
Sometimes financing is involved. Suppose the company paid Rs. 50,000 and got a loan for the rest of the purchase price.
The entry would be:
A year later, the company pays Rs. 450 to re-register the car with the motor vehicle department. This amount is charged to an expense, not to the asset account Vehicles. Routine repairs and maintenance are charged to expense as well. However, the company needed to replace the engine; which costs Rs. 25,000, that amount would be added to the asset account, not charged to expense. The entry to record the new engine would be:
>>> See Accumulated Depreciation
Types of Fixed Assets
A general guideline is that any expenditure that lengthens the life of the asset or improves its productivity or efficiency, and that lasts more than a year, gets added to the asset account, whereas any expenditure that is routine and ordinary in nature gets charged to expense.
The amount in the Land account is the cost of raw land or, if land with a building on it is acquired, the portion of the total purchase price that is allocated to the land. If there is a building on the land that is intended to be razed (knocked down) once the land is acquired, the cost of razing the building is added to the cost of the land. In addition, the cost of getting the land ready for its intended use is added to the Land account.
Land improvements are things done to the land that have a discrete useful life. These can include fencing, grading (changing the slope of the land), paving, and lighting. Land improvements are kept in an account separate from that of the land on which they sit.
Buildings can be built or purchased. If a building is built, the cost includes the architect’s fees, payments to contractors, and the cost of permits and inspections. If the building is purchased, the amount debited to the asset account includes the cost of the building, legal fees, survey costs, title insurance costs, and most costs paid at closing. Most repairs done to the building will be either charged to expense (for the usual, ordinary items) or set up as a separate asset account (such as a roof replacement or the purchase of a new boiler).
Equipment and Machinery
Equipment and machinery (sometimes they are kept in separate accounts) are those major tools and implements used in the operation of the business. For a service company, these can include computers, copiers, telephone systems, and any electronic gear. For a manufacturing company, they include such things as drill presses, lathe machines, sanders, and other large tools.
Furniture includes items such as desks, chairs, file cabinets, lamps, couches, and tables.
Fixtures are items such as store lighting, signage, and display cases.
Vehicles are the cars, trucks, and other transportation equipment that are owned by the company.
When a company buys a building or a piece of equipment, the cost is capitalized, or set up in an asset account. One of the principles of accounting is matching revenue with expense. If we own a building that is rented out as a store and offices, then it is involved in the production of revenue. How do we match the cost of the building to the revenue? A common denominator among all fixed assets is that they last longer than one year, and therefore they participate in generating many years’ revenue. That is where the concept of depreciation comes in— taking the cost of an asset and spreading it over the years that will benefit from having the asset. There are two common methods for depreciating an asset, straight-line and declining-balance. To calculate depreciation, three things have to be known: the cost of the asset, the method used to depreciate it, and its useful life. There is also a concept known as salvage value, but salvage value is used so infrequently in practice that we won’t include it in our illustrations.
>>> Further reading Journal Entry for Depreciation
Mukharji, A., & Hanif, M. (2003). Financial Accounting (Vol. 1). New Delhi: Tata McGraw-Hill Publishing Co.
Narayanswami, R. (2008). Financial Accounting: A Managerial Perspective. (3rd, Ed.) New Delhi: Prentice Hall of India.
Ramchandran, N., & Kakani, R. K. (2007). Financial Accounting for Management. (2nd, Ed.) New Delhi: Tata McGraw Hill.