This article is part of a larger series on Bookkeeping.
Fixed asset accounting is the process of capitalizing the purchase cost, allocating the cost over the asset’s useful life via depreciation, and removing the fixed asset from the books following a disposal. We go over each in detail and provide examples below.
What is a fixed asset in accounting? 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.
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. It’s a fundamental task of bookkeeping to correctly determine the total cost of the fixed asset because this amount must be capitalized and placed on the balance sheet as an asset versus being deducted against current earnings. You can read our Capitalize vs Expense article to learn more about expenditures that must be capitalized.
Here are some examples of expenditures that must be capitalized as the cost of the asset for a few common types of fixed assets:
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.
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:
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 less 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 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, 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:
Loss on sale of fixed asset
Read our article 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.
Fixed asset accounting consists of recording the asset’s cost, the periodic depreciation over the asset’s life, 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.