Accounting for Fixed Assets
Meaning of Fixed Assets
Fixed assets are those types of assets which are used by the business for more than one year for the purpose of generating revenues. Fixed assets may be tangible or intangible. Examples of tangible fixed assets are land, buildings, furniture and fixtures, machinery and equipment, vehicles, etc. Examples of intangible fixed assets are copyright, goodwill, patents, trademarks, etc.
Some of the major features of fixed assets are:
- Used in operations: the business owns its fixed assets and uses them in its operations to generate revenue and profit.
- Long term life: a business expects to use its fixed assets and gain an economic benefit from them for more than a year, which makes a fixed asset a long term asset.
- Capitalized cost: when a business purchases a fixed asset, it capitalizes its cost, meaning it records the cost on the balance sheet instead of as an expense on the income statement.
- Depreciation: if a fixed asset is anything other than land, the business transfers a portion of its capitalized cost on the balance sheet to an expense on the income statement each period, through a process called depreciation for tangible assets and amortization for intangible assets.
Types of Fixed Assets
There are two types of fixed assets:
- Tangible fixed assets: fixed assets that have a physical presence and can be touched, such as land, buildings, machinery and plant, vehicles, furniture, equipment, etc.
- Intangible fixed assets: fixed assets that have no physical presence and cannot be touched or seen, but can be bought and sold in the market. These include goodwill, trademarks, patents, software copyright, etc.
Meaning and Concept of Depreciation
Depreciation is the decrease in the value of fixed assets due to various causes. There are different types of assets in a business; some are current assets and some are fixed assets having a long period of useful life. The dictionary meaning of "depreciation" is decrease or reduction. According to W.L. Pickles, "Depreciation is the permanent and continuing diminution in the quality, quantity, or value of an asset."
Characteristics of depreciation:
- It is related to fixed assets only.
- It is a fall in the book value of an asset.
- It is a permanent decrease in the book value of an asset.
- It is a continuous decrease in the book value of an asset.
Causes of Depreciation
There are many causes responsible for the decrease in the value of fixed assets. The important ones are:
- Wear and tear: if a fixed asset is continuously used for a long period, its value decreases due to a decline in its working life and efficiency.
- Obsolescence: sometimes new technologies, changes in fashion, habits, etc. cause a decline in the value of fixed assets; this is called the obsolescence cause of depreciation.
- Fall in market value: if the market value of a similar asset falls, the value of the business's fixed asset also tends to decrease.