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Fixed asset

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Fixed asset, also known as a non-current asset or as property, plant, and equipment
(PP&E), is a term used in accounting for assets and property which cannot easily be
converted into cash. This can be compared with current assets such as cash or bank
accounts, which are described as liquid assets. In most cases, only tangible assets are
referred to as fixed.

Moreover, a fixed/non-current asset can also be defined as an asset not directly sold to a
firm's consumers/end-users. As an example, a baking firm's current assets would be its
inventory (in this case, flour, yeast, etc.), the value of sales owed to the firm via credit
(i.e. debtors or accounts receivable), cash held in the bank, etc. Its non-current assets
would be the oven used to bake bread, motor vehicles used to transport deliveries, cash
registers used to handle cash payments, etc. Each aforementioned non-current asset is not
sold directly to consumers.

These are items of value which the organization has bought and will use for an extended
period of time; fixed assets normally include items such as land and buildings, motor
vehicles, furniture, office equipment, computers, fixtures and fittings, and plant and
machinery. These often receive favorable tax treatment (depreciation allowance) over
short-term assets. According to International Accounting Standard (IAS) 16, Fixed Assets
are assets whose future economic benefit is probable to flow into the entity, whose cost
can be measured reliably.

It is pertinent to note that the cost of a fixed asset is its purchase price, including import
duties and other deductible trade discounts and rebates. In addition, cost attributable to
bringing and installing the asset in its needed location and the initial estimate of
dismantling and removing the item if they are eventually no longer needed on the
location.

The primary objective of a business entity is to make profit and increase the wealth of its
owners. In the attainment of this objective it is required that the management will
exercise due care and diligence in applying the basic accounting concept of “Matching
Concept”. Matching concept is simply matching the expenses of a period against the
revenues of the same period.

The use of assets in the generation of revenue is usually more than a year- that is long
term. It is therefore obligatory that in order to accurately determine the net income or
profit for a period depreciation is charged on the total value of asset that contributed to
the revenue for the period in consideration and charge against the same revenue of the
same period. This is essential in the prudent reporting of the net revenue for the entity in
the period.
Net book value of an asset is basically the difference between the historical cost of that
asset and it associated depreciation. From the foregoing, it is apparent that in order to
report a true and fair position of the financial jurisprudence of an entity it is relatable to
record and report the value of fixed assets at its net book value. Apart from the fact that it
is enshrined in Standard Accounting Statement (SAS) 3 and IAS 16 that value of asset
should be carried at the net book value, it is the best way of consciously presenting the
value of assets to the owners of the business and potential investor.

[edit] Depreciating a Fixed Asset


Depreciation is, simply put, the expense generated by the use of an asset. It is the wear
and tear of an asset or diminution in the historical value owing to usage. Further to this; it
is the cost of the asset less any salvage value over its estimated useful life. It is an
expense because it is matched against the revenue generated through the use of the same
asset. Depreciation is usually spread over the economic useful life of an asset because it
is regarded as the cost of an asset absorbed over its useful life. Invariably the depreciation
expense is charged against the revenue generated through the use of the asset. The
method of depreciation to be adopted is best left for the management to decide in
consideration to the peculiarity of the business, prevailing economic condition of the
assets and existing accounting guideline and principles as implied in the organizational
policies.

It is worth noting that not all fixed assets depreciate in value year-over-year. Land and
buildings, for example, may often increase in value depending on local real-estate
conditions.[1]

A Fixed Asset Register (FAR) is an accounting method used for major resources of a
business.

Fixed Assets are assets such as land, machines, office equipments, buildings, patents,
trademarks, copyrights, etc. held for the purpose of production of goods or rendering of
services and are not held for the purpose of sale in the ordinary course of business.

Fixed assets constitute a major chunk of the total assets in the case of all manufacturing
entities. Even in the case of service entities such as hotels, banks, financial institutions,
insurers, mobile / telephone service providers etc. it has become imperative to invest
heavily in furnishing, equipment, and technology to attract, and retain customers.

Just as it is important for a person investing on the NASDAQ to know those investments,
so it is important for a business entity to have a list of its fixed assets. A Fixed Asset
Register is that list of assets.
Objectives in maintaining a Fixed Asset Register (FAR)
A FAR must be kept in order to be in compliance with legislation governing
corporations, companies, etc. It allows a company to keep track of details of each fixed
asset, ensuring control and preventing misappropriation of assets. It also keeps track of
the correct value of assets, which allows for computation of depreciation and for tax and
insurance purposes. The FAR generates accurate, complete, and customized reports that
suits the needs of management.

A FAR also allows a company to keep track of fixed assets that are not under simple,
direct control of the company. This means owned and leased assets, assets under
construction, and imported assets.

The FAR can also be used to aid in capital budgeting and to keep track of amount
provided for Asset Retirement Obligation (ARO) in respect of each asset as required by
US GAAP (FAS – 143).

What Does Fixed Asset Mean?


A long-term tangible piece of property that a firm owns and uses in the production of its
income and is not expected to be consumed or converted into cash any sooner than at
least one year's time.

What Does Depreciation Mean?


1. In accounting, an expense recorded to allocate a tangible asset's cost over its useful
life. Because depreciation is a non-cash expense, it increases free cash flow while
decreasing reported earnings.

2. A decrease in the value of a particular currency relative to other currencies.

The charge of depreciation can impact the net profit in the income statement, so the
methods of calculating depreciation is very important. Adopting different methods of
calculation, the result will be different. And it'll refer to the expense and tax in the income
statement. Choosing the fit methods of calculating depreciation, it need to be faced by the
finance staff.

There are several possible methods of calculating depreciation:

1. straight line method


2. reducing balance method
3. sum of the digits method
4. revaluation method.
Straight line method

It's the simplest amd most popular methods of calcuating depreciation. Under this method
the depreciation charge is constant over the life of the asset. And we need know three
pieces of information:

1. the original (historical) cost of the asset


2. an estimate of its useful life to the business
3. an estimate of its residual value at the end of its useful life.

Annual depreciation charge = (Orginal - Residual value)/Estimated useful value

For example, a company purchased a car on 1 January at a cost of $24,000. The company
estimates that its useful life is four years, after which he will trade it in for $4,000. The
annual depreciation charge is to be calculated using the straight line method.

Depreciation charge = ($24,000 - $4,000)/4= $5,000 p.a.

[Example, Straight line depreciation]

On April 1, 2011, Company A purchased an equipment at the cost of $140,000.


This equipment is estimated to have 5 year useful life. At the end of the 5th year,
the salvage value (residual value) will be $20,000. Company A recognizes
depreciation to the nearest whole month. Calculate the depreciation expenses for
2011, 2012 and 2013 using straight line depreciation method.

Depreciation for 2011


= ($140,000 - $20,000) x 1/5 x 9/12 = $18,000

Depreciation for 2012


= ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

Depreciation for 2013


= ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

Reducing balance method

Under this method the depreciation charge will be higher in the earlier years of the life of
the asset. Here needs a percentage to apply. And in the first year the percentage is applied
to cost but in subsequent years it's applied to the asset's net book value (alternatively
known as written down value).

Sum of the digits method

The aim of this method is to show a higher depreciation charge in the early years of the
life of an asset.
Revaluation method

When a non-current asset has been revalues, the charge fro depreciation should be based
on the revalued amount and the remaining useful economic life of the asset.

Declining Balance Depreciation Method

Double declining balance depreciation


Depreciation = Book value x Depreciation rate
Book value = Cost - Accumulated depreciation

Depreciation rate for double declining balance method


= Straight line depreciation rate x 200%

Depreciation rate for 150% declining balance method


= Straight line depreciation rate x 150%

[Example, Double declining balance depreciation]

On April 1, 2011, Company A purchased an equipment at the cost of $140,000.


This equipment is estimated to have 5 year useful life. At the end of the 5th year,
the salvage value (residual value) will be $20,000. Company A recognizes
depreciation to the nearest whole month. Calculate the depreciation expenses for
2011, 2012 and 2013 using double declining balance depreciation method.

Useful life = 5 years --> Straight line depreciation rate = 1/5 = 20% per year

Depreciation rate for double declining balance method


= 20% x 200% = 20% x 2 = 40% per year

Depreciation for 2011


= $140,000 x 40% x 9/12 = $42,000

Depreciation for 2012


= ($140,000 - $42,000) x 40% x 12/12 = $39,200

Depreciation for 2013


= ($140,000 - $42,000 - $39,200) x 40% x 12/12 = $23,520

Double Declining Balance Depreciation Method

Book Value
Depreciation Depreciation Book Value at
Year at the
Rate Expense the year-end
beginning
2011 $140,000 40% $42,000 (*1) $98,000
2012 $98,000 40% $39,200 (*2) $58,800
2013 $58,800 40% $23,520 (*3) $35,280
2014 $35,280 40% $14,112 (*4) $21,168
2015 $21,168 40% $1,168 (*5) $20,000

(*1) $140,000 x 40% x 9/12 = $42,000


(*2) $98,000 x 40% x 12/12 = $39,200
(*3) $58,800 x 40% x 12/12 = $23,520
(*4) $35,280 x 40% x 12/12 = $14,112
(*5) $21,168 x 40% x 12/12 = $8,467

--> Depreciation for 2015 is $1,168 to keep book value same as salvage
value.
--> $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)

[Example, 150% declining balance depreciation]

On April 1, 2011, Company A purchased an equipment at the cost of $140,000.


This equipment is estimated to have 5 year useful life. At the end of the 5th year,
the salvage value (residual value) will be $20,000. Company A recognizes
depreciation to the nearest whole month. Calculate the depreciation expenses for
2011, 2012 and 2013 using double declining balance depreciation method.

Useful life = 5 years --> Straight line depreciation rate = 1/5 = 20% per year

Depreciation rate for double declining balance method


= 20% x 150% = 20% x 1.5 = 30% per year

Depreciation for 2011


= $140,000 x 30% x 9/12 = $31,500

Depreciation for 2012


= ($140,000 - $31,500) x 30% x 12/12 = $32,550

Depreciation for 2013


= ($140,000 - $31,500 - $32,550) x 30% x 12/12 = $22,785

150% Declining Balance Depreciation Method

Book Value
Depreciation Depreciation Book Value at
Year at the
Rate Expense the year-end
beginning
2011 $140,000 30% $31,500 (*1) $108,500
2012 $108,500 30% $32,550 (*2) $75,950
2013 $75.950 30% $22,785 (*3) $53,165
2014 $53,165 30% $15,950 (*4) $37,216
2015 $37,216 30% $11,165 (*5) $26,051
2016 $26,051 30% $6,051 (*6) $20,000
(*1) $140,000 x 30% x 9/12 = $31,500
(*2) $108,500 x 30% x 12/12 = $32,550
(*3) $75,950 x 30% x 12/12 = $22,785
(*4) $53,165 x 30% x 12/12 = $15,950
(*5) $37,216 x 30% x 12/12 = $11,165
(*6) $26,051 x 30% x 12/12 = $7,815

--> Depreciation for 2016 is $6,051 to keep book value same as salvage
value.
--> $26,051 - $20,000 = $6,051 (At this point, depreciation stops.)

How to Calculate Depreciation


Depreciation expense is calculated utilizing either a straight line depreciation method or
an accelerated depreciation method. The straight line method calculates depreciation by
spreading the cost evenly over the life of the fixed asset. Accelerated depreciation
methods such as declining balance and sum of years digits calculate depreciation by
expensing a large part of the cost at the beginning of the life of the fixed asset.

The required variables for calculating depreciation are the cost and the expected life of
the fixed asset. Salvage value may also be considered. Examples of depreciation
calculations for both straight line and accelerated methods are provided below.

Straight Line Depreciation Method


The straight line depreciation method divides the cost by the life.

SL = Cost / Life

Example: A desk is purchased for $487.65. The expected life is 5 years. Calculate the
annual depreciation as follows:
487.65 / 5 = 97.53
Each year for 5 years $97.53 would be expensed.

What if there is a salvage value?

Declining Balance Depreciation Method


The declining balance depreciation method uses the depreciable basis of an asset
multiplied by a factor based on the life of the asset. The depreciable basis of the asset is
the book value of the fixed asset -- cost less accumulated depreciation.

The factor is the percentage of the asset that would be depreciated each year under
straight line depreciation times the accelerator. For example, an asset with a four year life
would have 25% of the cost depreciated each year. Using double declining balance or
200%, which is the most common, would mean that depreciation expense in the first year
would be twice that or 50%. So to calculate the depreciation expense each year the
depreciable basis would be multiplied by 50%.

Example: A copy machine is purchased for $3,217.89. The expected life is 4 years. Using
double declining balance the depreciation would be calculated as follows:
factor = 2 * (1/4) = 0.50

Depreciable Depreciation Depreciation Accumulated


Year
Basis Calculation Expense Depreciation
1 3,217.89 3,217.89 * 0.5 1,608.95 1,608.94
2 1,608.94 1,608.94 * 0.5 804.47 2,413.41
3 804.48 804.48 * 0.5 402.24 2,815.65
4 402.24 402.24 * 0.5 201.12 3,016.77

What if there is a salvage value?

Sum of the Years Digits


The first step is to sum the digits or numbers starting with the life and going back to one.
For example, an asset with a life of 5 would have a sum of digits as follows: 5+ 4+ 3 +2 +
1 = 15
To find the percentage for each year divide the year's digit by the sum. In the example
above the percentage would be calculated as follows:

Year 1 5 / 15 = 33.34%
Year 2 4 / 15 = 26.67%
Year 3 3 / 15 = 20 %
Year 4 2 / 15 = 13.33 %
Year 5 1/ 15 = 6.67%
Example: A conference table is purchase for 1,467.89. The expected life is 5 years. Since
this is a 5 year asset the yearly factors have been calculated above.

Depreciation Depreciation
Year
Calculation Expense
1 1,467.89 * 33.34 % 489.40
2 1,467.89 * 26.67 % 391.49
3 1,467.89 * 20 % 293.58
4 1,467.89 * 13.33 % 195.67
5 1,467.89 * 6.67 % 97.91