What is Fixed Asset?
Fixed asset, in accounting, is defined as a long-term asset having lifespan > 1 financial year and value > capitalizing limit. They are typically bought to generate income. They are also known as Capital Assets and Property, Plant and Equipment (PP&E). These assets are normally not meant to sell or are not easily convertible into cash and therefore are categorized under non-current assets in the balance sheet.
Fixed Assets in Balance Sheet
A balance sheet consist of asset, liabilities and capital by shareholders. Further, assets are classified into current and noncurrent assets. Current assets are liquid assets which can be converted into cash within a period of one year. Whereas, noncurrent assets include fixed assets, investments by the company etc which are not easily converted into cash. In the balance sheet, the value of fixed asset is reported after deducting accumulated depreciation. It is rare but there are chances of value being affected by impairment of revaluation.
Types of Fixed Assets with their Examples
There are two types of fixed assets viz. Tangible Fixed Assets and Intangible Fixed Assets
Tangible Fixed Assets
Example of these assets is land, building, property, plant, equipment, computer, vehicle, machinery, etc. In short, the assets, which you can touch, are normally categorized as tangible assets.
Intangible Fixed Assets
Example of intangible fixed assets includes computer software, patent, trademark, copyright, goodwill etc. In the similar fashion you can define intangible fixed assets that you cannot touch.
Fixed Asset Accounting
In financial accounting fixed assets are treated in following three ways.
- Depreciation or Amortization for Tangible Assets and Intangible Assets respectively.
- Impairment of Asset – This is normally done when the market value of the Asset goes below the net book value of the Asset.
- Selling or disposing off the Asset
Fixed Asset Depreciation
Depreciation of fixed assets is done to calculate and include the cost of using fixed assets in the profit and loss statement. There are different methods of calculating depreciation – Straight Line Method, Accelerated, Double Declining Balance, and Units of Production Method, Written Down Value method. It is mandatory for a corporation to report financial statement with a consistent policy of depreciation and if the policy is changed it has to be reported separately. Fixed asset depreciation is a very crucial area also because the net profit shown in the financial statement is quite dependent on the method of depreciation. So, for an analyst, it is very important to consider this point. In addition to that, management of the company should understand the purpose of charging depreciation. It is to retain a part of the profit of the company so that when the replacement of fixed assets is required, the company can have sufficient funds to replace it. Depreciation should not be charged just to complete a formality. Since the objective is to avail sufficient funds to replace the asset at end of its useful life, it is important to consider the inflation factor also and thereby make an additional provision for the same. Selection of method of depreciation is also very important.
Fixed Assets Turnover
Fixed asset turnover ratio is a financial metric to understand how many times the revenue is earned relative to its investment in fixed assets.
Formula
Fixed Assets Turnover Formula = Net Revenues / Average Net Fixed Assets
Net revenue is the revenue exclusive of the returns and taxes and Average Net fixed assets mean fixed assets less depreciation.
Importance of Fixed Assets
Business Viability
Fixed assets are very important from the beginning. Without considering the value of fixed assets, possibility of fixed asset turnover, the life of an asset, it is not possible to accurately understand the viability of the business.
Fixed Asset Turnover
Once we have already invested in the fixed assets, the prime concern of the businessman to keep a check on fixed asset turnover. There are plants which run 24 X 7 for producing any product. Lack of orders/sales can underutilized fixed assets or reduce fixed asset turnover and the business can fall prey to losses especially due to the cost of using the assets i.e. Depreciation.
Return on Asset
The financial health is also determined in relation to the return on assets (ROA).
Break Even
The concept of break even and margin of safety is largely influenced by dependent on fixed assets.
Entry Barrier
One of the Porter five forces talks about barriers to entry. The fixed asset is one of the prime Contender as a barrier simply because higher the investment in these assets, the bigger the amount of total investment becomes.
Decision making /Investment decision
Importantly for any investment decision, it is very essential to forecast requirement of fixed assets into the business. Any wrong estimation about fixed assets will be very harmful in decision making.
(Source: efinancemanagement.com)
