Some businesses rely on plant, equipment, machinery, buildings and vehicles to generate an income for the company, such as a distribution business that owns a lot of trucks. These items, called fixed assets, can cost a lot of money and often represent a large part of the company's wealth. Companies record the value of these assets on the balance sheet so stakeholders have a snapshot of the company's overall financial health.
What Are Fixed Assets?
Fixed assets are things that a business owns and uses in order to carry out is operations. Examples include cars, buildings and manufacturing equipment. So, if you purchased an oven and a delivery scooter for your pizza restaurant, these items would be classified as fixed assets. The term "fixed" does not mean that the asset has to stay in one place and cannot be moved. Rather, it means that you're not going to use the item up or sell it within the current accounting year.
Fixed Asset Examples
Some fixed assets are tangible which means they have a physical form and you can touch them. Examples include buildings, computer equipment, furniture, machinery and vehicles. Other fixed assets are intangible which means you can't touch them. Examples include software licenses, concession agreements, trademarks and brands. Regardless of the form it takes, the test of whether something is a "fixed" asset is how long you hold the asset for. Inventory and accounts receivable will never be fixed assets, for example, because these items will swing to cash within a year of you holding them.
Why Fixed Assets Are Important
Information about fixed assets is recorded on the company's balance sheet and can represent a significant portion of the company's net worth. If you think about the type of assets that are categorized as fixed – land, buildings and machinery, for example – many are big-ticket items requiring significant capital expenditure, especially in manufacturing industries that require a large investment in plant and equipment. When a company is reporting a negative cash flow to purchase fixed assets, this could indicate that the business is growing or expanding its operations. Creating an accurate record of fixed assets helps managers, investors and stakeholders determine the company's overall financial health.
Understanding Fixed Asset Depreciation
The main feature of tangible fixed assets is they degrade and lose value as they age. Buy a truck today for $20,000, for example, and the chances are it will be worth only $12,000 when you sell it in three years. This drop in value over time is known as depreciation. Businesses need to show depreciation on the company's balance sheet so the company has an accurate record of the current market value at which the asset could sell for if you sold it today. There are tax implications, too. When you buy a fixed asset, the Internal Revenue Service does not let you deduct the expense all in one go. Instead, you have to spread or depreciate the expense over the number of years you'll be using the fixed asset.
How to Calculate Fixed Assets
There are lots of methods for calculating fixed asset depreciation but most accountants use the straight-line method. You'll need three numbers to run this calculation: the cost value, which is how much you paid for the fixed asset including shipping and installation, the amount you think you can sell the asset for when you've finished using it or the salvage value, which is $12,000 in the case of the truck, although this number is often zero and the number of years you think you'll use the fixed asset for which is its economic life. Deduct the "salvage value" from the "cost value" and divide the result by the item's "economic life." This will give you the amount of depreciation each year.
For an example of the straight-line method, suppose you buy some machinery for $30,000 and expect to use it for 10 years, after which time you'll scrap the machinery and buy new equipment to replace it. This asset will depreciate by $3,000 each year ($30,000/10). In the year of acquisition, you would record the machinery on your balance sheet with a value of $30,000. The next year, the machinery would have a recorded value of $27,000 and the year after that it would be $24,000. Run the same exercise for all your fixed assets, and transfer the figures to the "assets/ property, plant and equipment" column on your balance sheet.