Fixed Assets

Objectives of Fixed Asset Accounting

To give investors, creditors, management, tax

and regulatory authorities accurate
information about fixed assets
To account for use and disposal of fixed
assets
To plan for their acquisition through realistic
budgeting

Definition

A fixed asset is an asset that is held for the

purpose of producing or supplying goods or
services and not for sale in the normal course
of business.

Issues involved in Accounting for Property,

Plant and Equipment

Categories of Long-Lived Assets

Plant assets
Tangible
Include land, buildings and equipment

Intangible assets
Carry special rights without physical substance
Include patents, copyrights and trademarks

Plant Asset Terminology

Asset Accounts

Related Expense
Account

(Balance Sheet)

(Income Statement)

Plant Assets
Land

None

Buildings & Equipment

Depreciation

Furniture & Fixtures

Depreciation

Land Improvements

Depreciation

Natural Resources

Depletion

Intangibles

Amortization

Determining the Cost of Acquisition Valuation rules

Sum of all the costs incurred to bring

the asset to its intended use
Land
Purchase price,
commissions, survey &
legal costs, removal
of old buildings
Buildings
Purchase price,
commissions, sales &
other taxes, repairs &
renovation for intended use

Inc
i
l Co denta
mu sts
s
cap t be
ital
d
ize

Land Improvements
Fencing, paving,
security systems,
lighting
Machinery & Equipment
Purchase price,
Insurance in transit, sales
taxes, installation

Lump-Sum Purchases

Companies purchase several assets in a group

for one price
Cost is allocated to individual assets by on
their market values

SELF CONSTRUCTED FIXED ASSETS

The cost of a self-constructed fixed asset should

comprise those costs that relate directly to the
specific asset and those that are attributable to the
construction activity in general and can be
allocated to the specific asset.

NON MONETARY CONSIDERATION

When a fixed asset is acquired in exchange or in
part exchange for another asset, the cost of the
asset acquired should be recorded either at fair
market value or at the net book value of the
asset given up, adjusted for any balance payment
or receipt of cash or other consideration.
For this purpose fair market value may be
determined by reference either to the asset given
up or to the asset acquired, whichever is more
clearly evident.

OTHER CONSIDERATIONS

Assets acquired on Hire Purchase: recorded at their cash

value with a suitable disclosure, that the enterprise does not
have full ownership thereof.
Assets owned jointly with others: recorded in the Balance
sheet to the extent of the enterprises share in such assets,
original cost, accumulated depreciation and written down
value. Alternatively, the pro rata cost of those assets may be
grouped together with similar fully owned assets with an
appropriate disclosure.
Assets purchased for a consolidated price: Where several
assets are purchased for a consolidated price, the consideration
is apportioned to the various assets on a fair basis determined
by competent valuers.

Capital Expenditure

Capital Expenditure
Increase capacity or
extend life
Examples:
Major overhaul
Building additions

vs.

Immediate Expense

Immediate Expense
Maintain or restore to
working order
Examples:
Minor repairs
Painting

NOTE: Most companies set a rupee amount to decide if

an expenditure should be capitalized or expensed

REVALUATION OF FIXED ASSETS

When a revaluation is made, either an entire class of assets
should be revalued, or the selection of assets should be
made on a systematic basis. The basis should be disclosed.
The revaluation in financial statements of a class of assets
should not result in the net book value of that class being
greater than the recoverable amount of assets of that class.
When a fixed asset is revalued upwards, any accumulated
depreciation existing at the date of the revaluation should
not be credited to the profit and loss account

Measuring Depreciation on Plant Assets

Plant assets wear out or grow obsolete over
time
The cost of a plant asset is allocated to an
expense over its life
Matches expense of using the asset to the
revenues the asset helped produce
Land has an unlimited life and is the only plant
asset not depreciation

Depreciation

Depreciation is NOT:
a process of valuation
based on market value
decline

a method of setting
aside cash to replace
assets

Wear and tear

Technological factors
Product market
Regulatory limits
Contractual terms
Asset replacement
policies

How to Measure Depreciation

Three items needed

Cost of the plant asset
Estimated useful life
How long the company expects to use the
asset

Estimated residual value

Expected cash value of asset at the end of
its life
Depreciable
= Assets cost Estimated residual value
CanCost
be zero

Accounting for Depreciation, continued

Choosing a depreciation method

Straight-line method
Accelerated methods
Written-down-value
Sum-of-the-years-digits method

Production-units method

Comparing the depreciation methods

Comparing the Depreciation Methods

Illustrated

28 June 2011

PHI Learning Private Limited New Delhi

Comparing the Depreciation Methods

Illustrated

28 June 2011

PHI Learning Private Limited New Delhi

10

Impact of Depreciation

Each year:
Accumulated Depreciation increases
Book value decreases
Book value = Cost minus
accumulated depreciation

At the end of the assets life:

Book value = residual value

Considerations in Selecting a
Depreciation Method

Matching
Simplicity
Record-keeping costs
Tax

Depreciation for Tax Purposes

Most companies use straight-line for external

reporting
Most companies use accelerated depreciation
for tax purposes
Modified Accelerated Cost Recovery System
(MACRS)
Larger deductions early in assets lives helps
reduce taxes and increase cash flow

Partial Year Depreciation

Companies purchase plant assets when

needednot just at beginning of year
To compute depreciation for a partial year
1. Compute depreciation for a full year
2. Multiply by fraction of the year the asset is owned

For example, if an asset is purchased May 1,

multiply by 8/12

Not applicable to units-of-production

Life is not based on years

Changing Useful Life of Asset

A company may change useful based on new

information or experience
Called a change in estimate
Depreciation formula needs to be revised
Book value at time of change
Remaining useful life

Special Problems in Depreciation

Accounting

Partial accounting periods

Assets of low unit cost
Revising estimated useful life and
residual value

Myths about Depreciation

Myth 1: Depreciation is a source of

cash.
Myth 2: Depreciation is intended to
provide funds for replacement.
Myth 3: Depreciation is a valuation

Analyze the effect of a plant asset disposal

Disposal of Plant Assets

When a company is finished using an asset,

the asset can be:
Discarded
Sold
Exchanged

Before accounting for the disposal:

Depreciation is updated
Final book value is determined

Discarding Plant Asset

Accumulated depreciation and cost of asset removed

from records
Loss recorded (unless asset is fully depreciated and
no residual value)
JOURNAL
Date

Accounts

Accumulated depreciation
Loss on disposal of plant asset
Plant asset (equipment, bldg)

Debit

Credit

Selling a Plant Asset

If cash received > Book value

GAIN
Income Statement account
Similar to revenue; increases
net income

If cash received < Book value

LOSS
Income Statement account
Similar to an expense; decreases
net income

Book value = Cost Accumulated Depreciation

JOURNAL
Date

Accounts

Debit

Cash
Accumulated Depreciation
Loss on sale of equipment
Equipment
Record loss on sale of equipment

Cash
Accumulated Depreciation
Equipment
Gain on sale of equipment
Record gain on sale of equipment

Credit

Book value at time of sale:

Cost

$ 8,700

Accumulated depreciation
2004 ($8,700 x 2/5)

$ 3,480

2005 ($8700 - 3480) x 2/5

$ 2,088

January - September

x 9 /12

$1,566 $5,046

Book value September 30

$3,654

Cash received

$2,500

Loss on sale

$1,154

JOURNAL
Date

Accounts

Debit

Cash

$2,500

Accumulated Depreciation

$5,046

Loss on sale of equipment

$1,154

Equipment
Record loss on sale of equipment

Credit

$8,700

ACCOUNTING ON RETIREMENT
/DISPOSAL
Any profit/loss arising from retirement or disposal of fixed
assets should be dealt as below:
-Losses arising from retirement or gains/losses arising from
disposal of a fixed asset which is carried at cost should be
recognised in the profit and loss account.
-Where a revalued item of fixed asset is disposed off, any loss
or gain should be charged or credited to the profit and loss
account. However, to the extent that such loss is related to an
upward revaluation which has not been subsequently reversed
or utilised, it may be charged directly to that account.

Account for natural resources and depletion

Natural Resources

Come from the earth

Oil, minerals, coal and timber

Depletion records the expense related to extracting

the natural resource
Similar to units-of-production depreciation
JOURNAL
Date
12-31

Accounts
Depletion Expense
Accumulated Depletion

Debit

Credit

$$,$$$
$$,$$$

Account for intangible assets and amortization

Intangible Assets

Represent special rights and benefits

Have no physical form
Very valuable in todays information-driven
society
Examples include patents and copyrights

Categories of Intangibles

Finite lives that can be measured

Amortized using the straight-line method
Intangible asset is reduced by amortization
No Accumulated Amortization account

Indefinite Lives
Not amortized
Tested annually for loss in value

Specific Intangibles
Patents
Federal grants that give
holder exclusive right
to produce and sell an
invention for 20 years

Trademarks &
Trade Names
Distinctive identification of
product or service; a logo
or catch phrase

Copyrights
Exclusive right to sell a
book, music, file or other
work of art; lasts for the life
of the author + 70 years
Franchises & Licenses
Right to sell a product or
service with specific
Conditions, such as chain
restaurants

Goodwill

Very specific meaning in accounting

Only recorded when an entire business is
purchased
Purchase price exceeds fair value of net assets of
business

Represents earning power of purchased

business
Not amortized

Purchase price of MySpace

$18

Fair value of net assets

Current assets

$10

Long-term assets

$15

Total liabilities
Goodwill

($24)

$1
$17

JOURNAL
Date

Accounts

Debit

Credit

Current assets

$10

Long-term assets

$15

Goodwill

$17

Total liabilities

$24

Cash

$18

Research & Development Costs

Not an intangible asset

Required to be expensed as incurred
No guarantee expenditures will result in a
successful project

Financial Analysis of Fixed Assets

Utilization of fixed assets

Fixed asset turnover
Calculating fixed asset turnover ratio
Basis of comparison

Report plant asset transactions on the statement

of cash flows

Plant Assets and Cash Flow Statement

Operating section

Depreciation, amortization and depletion are

noncash expense
Added back to net income to determine operating
cash flows

Investing section
Purchases of plant assets and intangibles result in
an outflow of cash
Sales results in inflow of cash

DISCLOSURE

Gross and net book values of fixed assets at the beginning

and end of an accounting period along with additions,
disposals, acquisitions and other movements during the
year.
- Expenditure incurred in the course of construction or
acquisition.
- Revalued amounts substituted for historical costs of fixed
assets, the method adopted for revaluation, the nature of
indices used, the year of any appraisal made and whether
an external valuer was involved in carrying out the
revaluation.

DISCLOSURE REQUIREMENTS FOR DEPRECIATION

The historical cost each class of assets;

Total depreciation for the period.

The related accumulated depreciation;

Depreciation methods used; and

Depreciation rates (only if they are different from the principal rates
specified in the statute governing the enterprise.)

Rates as per Schedule XIV

Provisions of the Income Tax Act

Rates of depreciation as per Appendix I Rules 5