Fixed Asset

What Is a Fixed Asset?

Fixed assets are tangible, long-lived assets used by a company in its operations, such as machinery, factories, tools, furniture and computers. They are listed in the noncurrent asset section on a company’s balance sheet because their useful lives extend beyond one year.

Fixed Asset

Examples of Fixed Assets

Fixed assets come in many forms. They are usually inventoried individually but grouped as follows in the fixed asset accounts in a company’s general ledger:

1. Land

Land used for business operations is a fixed asset. Land held for speculation or resale (as by a real estate company) is not a fixed asset.

2. Buildings and factories

Offices, warehouses, factories, workshops, and garages are among the fixed assets in this category.

3. Furniture and fixtures

Office equipment, desks, and tables are considered fixed assets, as are fixtures such as sinks, cubicle walls, or rugs (that is, any built-in item that cannot be removed without damage to the asset).

4. Leasehold improvements

Additions and upgrades to leased or rental property — think: retail shelving, paint, erection of office walls, carpentry, electrical and plumbing upgrades — are fixed assets.

5. Computer hardware, software, and office equipment

Computer hardware is a fixed asset, including tablets, PCs, and servers. Purchased software, like enterprise packages and cloud-based applications, are also considered fixed assets. Office equipment like copiers and telephones are included, too.

6. Vehicles

Cars, trucks, tractors, and forklifts are examples of fixed-asset vehicles.

7. Machinery and equipment

Heavy-duty machinery — like assembly lines, cranes, and equipment such as X-ray machines, lawnmowers, and pizza ovens — is considered a fixed asset.

8. Tools

Typically, low-price tools may be expensed, but higher-value items that last more than a year are included in fixed assets. Companies typically set a “materiality threshold” for including tools in fixed assets.

Assets vs. Fixed Assets

Assets are one of seven accounting elements: assets, liabilities, equity, revenue, expense, gains and losses. “Assets” is the umbrella term for all resources that have value and are controlled by their owner, such as cash, machinery, and patents. Fixed assets constitute the PPE (property, plant, and equipment) subset of total assets.

Fixed Assets vs. Current Assets

Fixed assets and current assets are two classifications of assets; they are distinguished from each other based on the amount of time it would take to be converted to cash. Current assets include cash and other assets that can be easily converted to cash within a 12-month period. Examples include money market accounts, inventory, securities, and accounts receivable.

Fixed assets are held for more than a year because they have longer useful lives and are not expected to be converted to cash sooner.

Examples include vehicles, manufacturing equipment, furniture, and buildings. Fixed assets are depreciated over their useful life, unlike current assets, which are not depreciated. Fixed assets are reported as PPE on a company’s balance sheet in the noncurrent asset section.

Different Asset Classifications

Overall, “assets” is the broad term for all resources controlled by a company, from cash to patents. Given the potential diversity of a company’s assets, asset classifications can become confusing for people who don’t deal with them often.

Among the several subsets under the assets umbrella there are current assets and fixed assets (as described above) as well as tangible/intangible.

For example, inventory is classified as a tangible asset; accounts receivable and patents are classified as intangible assets. In addition, assets are often described as operating vs. non-operating, but these are descriptors rather than official balance sheet classifications.

An assembly line would be an operating asset; the CEO’s company car would be nonoperating and likely listed under “Other Assets.”

Differences Between Fixed Assets & Current Assets

1. Current Assets

  • Easily Converted to Cash: Yes
  • Useful Life: Less than 12 months
  • Operating Assets: Yes
  • Tangible: Sometimes
  • Depreciable: Sometimes
  • Examples: Cash, Accounts Receivable, Inventory, Prepaid Expenses
  • Where disclosed on Balance Sheet: Under Current Assets
  • Potential Income Statement impact: Varied (e.g., uncontrolled accounts receivable hit as bad debt expense; Old inventory written off as obsolescence expense).
  • Affected Statement of Cash Flow section: Operating Activity (except for land)

2. Fixed Assets

  • Easily Converted to Cash: No
  • Useful Life: Longer than 12 months
  • Operating Assets: Yes
  • Tangible: Yes
  • Depreciable: Yes
  • Examples: Vehicles, Machinery, Equipment, Land
  • Where disclosed on Balance Sheet: Under Noncurrent Assets
  • Potential Income Statement impact: Related depreciation expense; or any gain/loss on sale or other disposal.
  • Affected Statement of Cash Flow section: Investing Activity (except for land)
  • Fixed assets are the property, plant, and equipment — with multiyear useful lives — that form the backbone of a business.

Why Are Fixed Assets Important?

Fixed assets are important primarily because they help the business do its work and earn revenue. In addition, because of their high value, fixed assets increase a company’s net worth and can also be used as collateral for loans. More specifically:

1. They support the business.

Most companies require fixed assets to generate revenue. Some fixed assets, like machinery or vehicles, are directly deployed to provide products or services, while others support administrative functions. Office furniture and computer hardware are examples of the latter. The addition of fixed assets may enable a company to expand its current level of production.

2. They increase a company’s valuation.

Fixed assets tend to be high-value items and, thus, represent a significant part of a company’s overall value. The more fixed assets a company has, the higher its valuation may be to investment, merger, and acquisition partners. This is especially true in industries that are very asset-intensive, such as manufacturing, where the ratio of fixed assets to total assets is high.

3. Their value can help drive growth.

The value of a company’s fixed assets can be used as collateral for loans companies can use to pursue new opportunities. Access to additional capital, such as a revolving line of credit collateralized by a company’s warehouse, may help a business improve its cash flow.

Benefits of Fixed Assets

Fixed assets are included on a company’s balance sheet, but their benefits don’t stop there. The accounting treatments of fixed assets influence income statements, statements of cash flows, and tax returns, where the benefits they impart are the result of capitalization — the accounting treatment that records an asset on the balance sheet at acquisition and reduces its value via depreciation over time, rather than expensed all at once.

Here’s how fixed assets benefits flow through each type of financial statement:

1. Balance sheets

Fixed assets are followed by investors assessing the value of a company and are shown in the noncurrent asset section of the balance sheet, net of the associated accumulated depreciation. This net value reflects ongoing reduction in value as the fixed asset ages.

The balance sheet separates PPE fixed assets from other noncurrent assets because PPE is a line item that is often analyzed by external investors and partners when valuing a company.

2. Income statements

While fixed assets appear as part of the balance sheet, the related depreciation expenses are shown on the company’s income statement. There are several depreciation methods that comply with the Generally Accepted Accounting Principles (GAAP), all aimed at spreading the cost of a capitalized asset over the time that that asset continues to provide economic benefit.

For example, the costs of a $100,000 forklift with an estimated useful life of 10 years would be more fairly represented on the income statement as a $10,000 expense per year of its life, rather than as a single, $100,000 expense in the year of acquisition and $0 in each of the subsequent nine years.

3. Statements of cash flows

There are two ways fixed-asset treatment benefits are reflected in a company’s statement of cash flows. First, the depreciation expense that was included in net income on the income statement is reversed on the statement of cash flows, since it is a noncash expense.

Doing this helps maintain focus only on cash expenses, for purposes of analyzing liquidity. Second, all fixed asset activity is contained within the “cash flows from investing activity” section of the statement of cash flows, to separate it from continuing operations.

Although fixed assets are fundamental to operations, purchasing and disposing of fixed assets are unique, non recurring transactions, so it helps to capture the activity separately from the day-to-day operating activities.

4. Tax returns

Fixed assets enjoy special tax benefits in the U.S. and abroad. Specifically, the U.S. tax code allows companies to reduce their taxable income for depreciation. By doing so, a company can maximize its fixed asset “deduction” by spreading it out over time and allowing it to offset revenue in multiple periods.

In fact, the U.S. Internal Revenue Service (IRS) uses accelerated methods of depreciation that achieve the spreading effect over a shorter time than GAAP guidance suggests. For example, a vehicle may depreciate over five years for tax purposes but may have an eight-year useful life for GAAP accounting. It’s important to check with your tax adviser to be aware of all possible benefits available in specific tax jurisdictions.

A key exception to this discussion relates to land. Like other fixed assets, land is capitalized on the balance sheet. However, land does not depreciate and does not affect the income statement, statement of cash flows, or tax returns in the same way as other fixed assets.

Land does not qualify for depreciation because it does not decline in value from use, exhaustion, and obsolescence in the same way a piece of machinery might.

Characteristics of Fixed Assets

When determining the proper classification of an asset, there are several characteristics that set fixed assets apart from other asset types.

1. Purpose

Companies acquire fixed assets for use in operations that support the production of goods or services — they are not acquired for resale. For example, a construction company would buy a truck for use on job sites, not to resell. Nor are fixed assets incorporated into finished goods, like raw material assets would be. For example, lumber cannot be a fixed asset for the construction company since it ultimately becomes part of the completed building.

2. Long life

By their nature, fixed assets are beneficial for more than one fiscal cycle, often for many years. Because of this, their value is depreciated over the course of the fixed asset’s useful life in accordance with the matching principle of accounting, rather than as a single expense in the period purchased. For example, a warehouse is expected to last for several years and is depreciated over time. Land is a notable exception.

3. Tangibility

Fixed assets are substantial — they are tangible assets that physically exist. Examples include tools and machinery. By contrast, long-lived intangible assets, such as patents, are noncurrent assets but are not considered fixed assets.

4. Accounting for Fixed Assets

Since fixed assets are long-lived, the accounting issues for them change over their life cycle. Fixed assets are initially capitalized when acquired and then systematically depreciated over the course of their useful lives. While they are in operation, their value is reassessed and adjusted downwardly for any impairment detected by periodic comparison to market value or whenever an unusual circumstance occurs. Ultimately, the accounting processes related to their disposal, retirement, or scrapping reflect these reevaluations, possibly creating a gain or loss on the fixed asset.

Fixed Assets and Financial Statements

At acquisition, fixed assets are recorded on the balance sheet at the price paid plus any additional costs to make it ready for use, such as installation costs. Depreciation expenses hit the income statement each period.

A “contra-asset” account on the balance sheet, called accumulated depreciation, is where periodic depreciation charges accumulate, reflecting the running balance of the fixed asset when combined with the asset account.

This net value is periodically compared to market value, especially if something significant occurs with the fixed asset, such as a fire.

Accountants reduce the value of fixed assets for impairment, but they do not increase the value unless actual expenditures are made to increase the amount capitalized.

Depreciation of Fixed Assets

Depreciation is the systematic reduction of the value of a capitalized asset over time. Depreciation expense for a given period is a debit that reduces income on a company’s income statement, and the offsetting credit builds up in the accumulated depreciation account on the balance sheet.

A critical part of accounting for fixed assets is determining the length of an asset’s useful life, or how long the asset will yield economic benefit. This estimate should be based on some reasonable expectation, such as anticipated usage. Both GAAP and the IRS provide guidance on the length of useful life for distinct types of fixed assets.

Another part of accounting for depreciation of fixed assets is estimating whether the asset will have any salvage value when disposed of, which would reduce a fixed asset’s depreciable base.

The last step is to select an appropriate depreciation method, such as straight-line, units of production, or declining balance. The method selected may differ for financial statement purposes versus tax filings.

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