Accounting for Fixed Assets
Fixed assets are assets that are purchased by an organization for long-term use that help generate income. Examples of fixed assets are land purchased for investment or use, buildings, factories, machinery and equipment.
Fixed Assets are also referred to as Non-Current Assets, as these assets will not (or should not) be converted into cash within the next 12 months.
Fixed assets appear in the financial records at their net book value, which is its original cost, minus accumulated depreciation. Because of ongoing depreciation, the net book value of an asset is always declining.
These fixed assets are shown in the financial statements in two ways:
1 – Historical Cost – once a fixed asset is purchased, it has to be recorded in our financial records. The purchase price paid (to the supplier) has to be added to any import duties, other taxes paid, as well as any expenses/costs paid to bringing the asset to the working condition of its intended use, such as set up and consultancy fees.
2 – Revalued Price – as fixed assets are utilized, the value of these assets decrease. This is what leads to the Depreciation principle. Depending on the class of asset, a specific depreciation rule will be applied.
Depreciation is the allocation of the cost of a fixed asset over its useful life to match a cost against revenues that this asset helped to generate.
There are three main depreciation methods used:
Straight Line method – this method allocates the value of the asset over the estimated life of that asset. For example, computers & laptops have a 3-year life with no residual value at the end. Therefore the cost of these assets would be depreciated equally over three years.
Diminishing Value - allows companies to write off their assets faster in earlier years than the straight-line depreciation method and to write off a smaller amount in the later years, as the asset would be working harder / used more in the earlier years of its life.
Units of Use – This method allocates depreciation expense according to a fixed rate per unit of production. Under this method, one must first determine the cost per one production unit and then multiply that cost per unit with the total number of units the company produces within an accounting period to determine its depreciation expense.
Once the depreciation expense has been calculated, you would need to Debit the depreciation expense and Credit the Accumulated Depreciation account. The expense account would be closed off at the end of the accounting period, and the Accumulated Depreciation account would be shown as a negative Current Asset in the Balance Sheet, being deducted from the specific class of asset that is being depreciated.
Accounting Standards have been drawn up for companies to follow, so that everyone is treating their asset class in the same way, and that there is no way of manipulation with their Financial Results.
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