Fixed asset accounting is the process of capitalizing the purchase cost, allocating the cost over the asset’s useful life via depreciation, testing the fixed asset for impairment, and removing the fixed asset from the books following a disposal. We go over each in detail and provide examples.
Key Takeaways
- Fixed assets are long-term assets that are expected to be used for more than one operating cycle. They generate revenue over multiple periods. Therefore, their cost should be deducted against profit over multiple periods. Learn more about the type of assets included as property, plant & equipment.
- Upon purchase of a fixed asset, you need to account for its cost by summing up its price and other costs—such as installation, training, insurance, shipping, and taxes.
- Depreciation happens when you start using the asset, so you need to select a depreciation method that best fits the fixed asset’s usage patterns.
- Disposal of fixed assets happens when the business decides to retire the asset. This involves writing down or removing the fixed asset from the books, including its accumulated depreciation. See how accumulated depreciation differs from depreciation expense.
- Impairment testing is not mandatory for small businesses that aren’t listed in the stock exchange. However, they may still follow United States Generally Accepted Accounting Principles (US GAAP) rules voluntarily.
- Upward changes in the fixed asset’s value are called revaluations, and the US GAAP explicitly disallowed revaluations for fixed asset valuation.
1. Accounting for the Fixed Asset Cost
The largest chunk of a fixed asset’s cost is its purchase or construction price. However, costs incurred to place the asset in service should also be included in the total cost of the fixed asset. A fundamental bookkeeping task is to determine the total cost of the fixed asset correctly because this amount must be capitalized and placed on the balance sheet as an asset versus being deducted against current earnings.
Here are some examples of expenditures that must be capitalized as the cost of the asset, and you can check out our guide on when to capitalize vs expense to learn more:
Land | Building | Machinery |
|---|---|---|
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Manage your fixed assets using specialized software: Our roundup of the best fixed asset management software recommends leading solutions for managing assets from purchase until disposal.
2. Accounting for Fixed Asset Depreciation
Depreciation is a method of allocating the cost of a fixed asset over the life of the asset. Since fixed assets generate revenue for more than one period, it’s important to deduct the cost of the asset over the same period as the life of the asset.
Common depreciation methods include:
- Straight line
- Double declining balance
- Sum-of-the-years digits
- Units of production
Here’s a quick illustration of depreciation. Let’s assume that we have a fixed asset with a cost of $50,000 and salvage value of $2,000. It has a useful life of five years. By applying the straight line method, our annual depreciation expense would look like this:
2013 | 2014 | 2015 | 2016 | 2017 | |
|---|---|---|---|---|---|
Depreciation Expense | $9,600 | $9,600 | $9,600 | $9,600 | $9,600 |
Accumulated Depreciation | $9,600 | $19,200 | $28,800 | $38,400 | $48,000 |
Straight line depreciation = ($50,000 – $2,000) ÷ 5 years = $9,600/year
By the end of the asset’s useful life, the book value (cost minus accumulated depreciation) will be its salvage value of $2,000 ($50,000 – $48,000).
You can find additional details about calculating depreciation expense in our article on how depreciation works.
3. Accounting for Impairment
In general, companies must decrease the book value of their fixed assets and record an impairment loss when the book value exceeds the recoverable amount. Impairment accounting is a requirement for businesses needing to comply with the US GAAP, such as publicly listed companies. Most small businesses don’t enlist in the stock exchange, so GAAP compliance isn’t mandatory. However, small businesses may freely follow the US GAAP for financial reporting.
US GAAP rules state that companies need to test for impairment when there are signs of impairment. GAAP calls these “triggering events”—which is defined as an event giving rise to the possibility of the asset’s fair value being less than its carrying amount. Learn more by reading What is Fixed Asset Impairment in Accounting.
Another concept in fixed asset measurement is revaluation to increase the carrying value of an asset to its fair market value (FMV). Unfortunately, the US GAAP explicitly states that in all instances, fixed assets should not be revalued upward to its FMV. Meanwhile, the International Financial Reporting Standards (IFRS)—the international counterpart of the US GAAP—allows revaluation accounting. This difference makes the IFRS more flexible in fixed asset valuation than the US GAAP.
4. Accounting for a Fixed Asset Disposal
At the end of a fixed asset’s useful life, the business owners can either sell the asset or retire the asset. When we dispose of fixed assets, we need to remove the cost of the asset and its accumulated depreciation from the books. If we sell the asset for more than its book value, we recognize a gain. If we sell it for less than its book value, then we recognize a loss.
By using the preceding example, let’s assume that we sold the asset with a $2,000 book value for $1,100 to a scrap dealer. Our entry to record this disposal transaction would be:
Debit | Credit | |
|---|---|---|
Cash | 1,100 | |
Accumulated Depreciation | 48,000 | |
Loss of Sale of Fixed Asset | 900 | |
Fixed Asset | 50,000 |
Read our guide on recording the disposal of fixed assets to learn how to record gains, losses, and exchanges of fixed assets for a variety of disposal scenarios.
If you want to learn more about bookkeeping in general, head out to our guide on what bookkeeping is and what a bookkeeper does.
Additional Resources:
- How To Make a Depreciation Worksheet in Excel
- Free Fixed Asset Rollover Template
- What Is Net Fixed Assets Formula
- Current Assets vs Fixed Assets: What’s the Difference?
Frequently Asked Questions (FAQs)
Fixed assets (technically called as property, plant, and equipment) are comprised of land, buildings, furniture and fixtures, leasehold improvements, computer equipment and software, vehicles, machinery, and tools.
A fixed asset is a noncurrent or long-term asset because of its long life. Current assets, on the other hand, are short-term assets that are expected to be converted into cash within the company’s operating cycle. Our article on assets in accounting has a detailed discussion of long-term vs current assets.
Bottom Line
Fixed asset accounting consists of recording the asset’s cost, the periodic depreciation over the asset’s life, impairment testing, and the asset’s eventual disposal. You can get a much better measure of profit and loss if you account for your fixed assets properly versus deducting them when purchased, which is often allowed for federal income tax purposes.
