Fixed assets are long-term assets that are used in the production of goods or services, or for administrative purposes. They have a useful life of more than one year and are not intended for sale in the ordinary course of business.
Accounting for fixed assets is important for businesses because it allows them to track the cost of their fixed assets, depreciate them over their useful lives, and report them on their financial statements.
The accounting for fixed assets can be divided into the following steps:
The first step in accounting for fixed assets is to acquire them. When a business acquires a fixed asset, it must record the asset at its historical cost, which is the amount of cash or other consideration paid for the asset.
The historical cost of a fixed asset includes the following costs:
- The purchase price of the asset
- Any costs incurred to get the asset ready for use, such as transportation, installation, and testing
- Any interest incurred on the debt used to finance the purchase of the asset
The cost of a fixed asset is allocated over its useful life through depreciation. Depreciation is the process of allocating the cost of a fixed asset to the periods in which it is used.
The amount of depreciation expense recognized each period is determined by the depreciation method used. There are several different depreciation methods, including the following:
- Straight-line depreciation is the most common method. It allocates the cost of the asset equally over its useful life.
- Declining-balance depreciation allocates a greater amount of depreciation expense in the early years of the asset’s useful life.
- Units-of-production depreciation allocates depreciation expense based on the number of units produced or used by the asset.
The value of a fixed asset may decline below its carrying amount due to impairment. Impairment occurs when the carrying amount of an asset exceeds its fair value less costs to sell.
When an asset is impaired, the business must reduce the carrying amount of the asset to its fair value less costs to sell. This reduction is recorded as an impairment loss.
Fixed assets are reported on the balance sheet as property, plant, and equipment. The cost of fixed assets is reported at its historical cost, less accumulated depreciation and accumulated impairment losses.
Accounting for fixed assets is an important part of financial accounting. By following the proper accounting procedures, businesses can ensure that their fixed assets are accurately recorded and depreciated over their useful lives.
In addition to the above, there are some other important concepts to keep in mind when accounting for fixed assets:
- Revaluation is the process of increasing the carrying amount of a fixed asset to its fair value. Revaluation is only permitted under certain circumstances, such as when there has been a significant increase in the fair value of the asset.
- Disposal occurs when a fixed asset is sold, retired, or otherwise disposed of. When an asset is disposed of, the business must record a gain or loss on the disposal.
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