Fixed Assets Accounting
When we refer to fixed assets, we are referring to longer term assets. These are assets that are going to last more than one year.
Whilst in fixed assets accounting they are referred to as fixed assets, sometimes they are referred to as plant property and equipment.
There are several types of long term assets.
The term plant, also referred to as fixed assets, sometimes grouped as property, plant, and equipment. There are a few different names for them. These assets are tangible in nature, which means that we can physically use them. We can actually use equipment. We can use a building – any asset that we can use and actively used in operations over a longer period of time. The rule of thumb lasting for more than one year so they’re use is expected to benefit future accounting periods. Property plant and equipment is also abbreviated to the acronym PPE (PP&E).
What is fixed asset depreciation
The issue with plant assets is that we have to account for the actual acquisition of them. In other words, we purchase them. We have to put them on the books. We have to figure out how we’re going to record them taking into account the historical cost principle. Basically, that means we record assets at the price we paid for that asset, the original cost of it, regardless of what it’s currently valued at on the open market. So regardless of whatever we think we can sell it for now, we’re going to leave it at its original cost. That is how we acquire assets.
Now that’s not going to be counted as an expense right away until we use it up over its life. So what’ll happen here is that as we use it over the next 10, 15, 20 years, however many years, we think it’s going to last us. We need to spread that cost out. We need to allocate that cost to those periods that benefited from it – this is known as depreciating the asset.
We’re basically saying that this asset helps us generate revenue for its productive life. We need therefore to match current expenses with that revenue – the matching principle. This is another application of it. We’re matching expense with the life of the asset, with the revenue it helped to generate over that life.
Let’s say we purchased an asset originally, but now we need to repair it. We need to overhaul the engine if it’s a vehicle or if it’s a building, let’s say it’s a hospital, we need to add a brand new ward. We have to figure out how do we account for those subsequent expenditures? Do we add them to the assets cost? Does it really add to the value of that asset? Or do we just count it as an expense right away and determine we are going to count it against that year’s revenue. Those are some options.
Then at the end of the asset’s life, we have to figure out how to dispose of it. How do we record that disposal? Get it off the books. We no longer own it. Maybe we’ve sold it. Maybe we donated the fixed asset to a charity. Maybe we just completely abandoned it. Whatever the case may be. We have to get it off our books because we’re no longer using it.
Asset Acquisition and Purchase Cost
So the first topic there was cost, how do we determine the acquisition cost itself? On first look it’s a pretty simple answer – the purchase price. We can easily account for the price that we actually paid to buy this asset. Of course that’s a big part of it. The actual invoice cost of that asset, but very similar to inventory, invoice price is not everything. We may have had to pay transport/freight costs to ship this asset to us. We may have had to actually pay someone to install it. Perhaps the asset required calibration/testing. All of these things count as part of this acquisition costs. Basically any expenditure needed to prepare the asset for its intended use is a part of the acquisition cost.
Another example of acquisition costs, especially with building assets when installing equipment, you might have to rip down part of a wall to fit it in the building in where it’s going to go. So maybe there was a wall where you wanted to set this equipment that might be part of the acquisition cost. There are a lot of things that are included in this. Also financing charges and up-front payment discounts. Cash discounts are not included because we didn’t have to pay that amount. So that’s not a surprise. Financing charges we agree to (interest) if we borrowed to buy the asset is also not included as a cost in the acquisition of an asset subject to fixed assets accounting depreciation.
Land and building assets have various cost inclusions that get included as a part of the initial acquisition cost. Think of taxes, surveying fees, stamp duty, real estate agent commissions, transfer fees, title searches, etc. Whilst the buildings are depreciable under Division 43 of the Income Tax Assessment Act (ITAA) 1997, land is not.
The point of depreciation is to show that you’ve used up the asset and you’ve spread that cost out over its life. Land doesn’t have a specific life – that land is going to be there forever. Land improvements, buildings, carparks, driveways, fences, lighting systems. These are things that we add to the land that is subject to asset depreciation.
This leads to an interesting discussion when you make a lump sum asset purchase. I.E when you purchase a number of assets for one lump sum purchase price. Say we bought a building, we bought a piece of land. We bought some equipment, but we paid one price for the whole lot.
For accounting purposes we have to figure out how much cost gets allocated to each of those individual assets. We can’t record them as one asset. We can’t record those three different things as one asset. Firstly because we already know land doesn’t get depreciated. But all the other assets encompassed in the purchase will have different effective lives for asset depreciation purposes.
The solution is to get an appraisal based on the whole purchase price for each of the assets that made up the whole purchase price.
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Depreciation and an asset’s effective life
We’ve covered the purchase price and how much we allocate to the purchase of an asset. Now how do you spread the cost out over the rest of an asset’s effective life?
The key thing to note here is we really want to best match the expense with revenue. We want to make sure every year of that assets life has a proportionate cost allocated to it. Depreciation is the process of allocating costs to expense in the various accounting periods against the asset.
When we talk about depreciation from accounting perspective, we’re not necessarily talking about fair market value decline. We’re talking about the fact that we’ve used up some of that cost or we’ve allocated some of that cost to an expense in that year. It’s about the decline in book value, not necessarily the fair market value. It may be close, but we’re not trying to approximate that decline in fair market value. At the end of your use of the asset you may sell it and you may make a gain or a loss. We start with the balance sheet, the asset is recorded at its cost, and we allocate that cost out to the income statement. Basically the expense depreciation expense, we show that we’ve used up some of that cost.
In order to calculate depreciation, we have to know the cost, which as discussed above should be easy to work out or obtain. You don’t necessarily need to know what the salvage value will be – you can account for this at the end of the asset’s life when you either dispose of or sell the asset. It can be treated then as a writeback, profit or loss.
AssetAccountant™ fixed asset software will can easily account for the taxable use allocated to the asset when you dispose of it also.
We also need to have an estimate of what the asset’s useful life is. Taxation Ruling TR 2019/5 is Australia’s guide for this value for all classes of depreciable assets. The Commissioner of Taxation issues the annual taxation ruling, TR 2019/5, which contains the effective life of depreciating assets under s 40-100 of ITAA 1997. It contains new effective life determinations which have been incorporated into Tables A and B in the Schedule to TR 2019/5.
Methods of Fixed Asset Depreciation
So with the above in mind, we need to determine the appropriate method of depreciation we use for an asset.
The two most common methods are Prime Cost (also known as Straight Line Depreciation Method) and Diminishing Value (DV). AssetAccountant™ fixed asset accounting software accommodates these two and all other common methods of depreciation.
If we concentrate on probably the most common and best known, Prime Cost Method of asset depreciation. It means we’re going to have the exact same amount of depreciation expense every year of this asset’s life. We’re going to make it straight across the board. We’re going to split it out evenly to calculate this, to calculate the depreciation expense depreciation expense for each period of the asset’s effective life.
Prime cost method of fixed assets accounting depreciation – Transcript
This is an example of prime cost method depreciation, otherwise known as straight line method depreciation. We are now inside the AssetAccountant™ application, which you can find at https://app.asset.accountant.
Once you have an account, assuming you’ve created one or you are a customer or you are trialling our fixed assets accounting software, you just input in your username and your password to sign in.
Once signed in, you’ll be greeted by the dashboard. This is a sample register I use for testing. You can see the name of the organisation and the name of the register.
You can toggle between tax view and accounts. You can also select which period you want to have the view in.
Asset groups is the next tab over and you’ll see furniture and fittings, computer equipment, just five of the standard ones for today’s exercise.
I’m going to choose furniture and fittings. And in here you’re able to allocate a name, a description, you can put in an initial purchase cost, a capital gains tax allowance, if you want that to be accounted for.
But most importantly here is the asset group depreciation settings.
Here is your method for tax depreciation and your method for accounts depreciation.
This determines what default settings will be made for new assets from this time on.
Of course these can be altered at the asset level.
If you want to show an asset for accounts view, and one for tax view, that is entirely possible. I’m going to add a new asset. Let’s just call it a test asset.
We are able to put in serial numbers if we wish to do so. And I’m going to allocate this particular asset to furniture and fittings. Let’s say it’s $1,000. And our purchase date is the 1st of August.
We can make a lot of choices here. You can choose separate values for tax depreciation and accounts depreciation. So I’m going to leave this just as the standard prime cost over 10 years for both accounts and tax, and I’m going to save this.
I’m just going to change our view to this financial year, and you’ll see it projects, the depreciation using the prime cost method over this time. We have our purchase value of a thousand dollars, which was on the 1st of August and what it does is it calculates the $100 per year (10% depreciation) and calculated as a daily value.
This daily value is multiplied by how many days in the month to give us our depreciation amounts for journal entries.
I have seen a lot of niche products come and go but the one constant has been the lack of a decent fixed asset register. I was recently invited to see the latest incarnation and it did not disappoint. I am confident that both accounting firms and corporate clients will be lining up to use it – I have already been extolling the solutions’ virtues.
Alan FitzGerald - Founder, Practice Connections