How to account for a fixed asset
Regardless of the type of business, the size of business, the business’ customer base or the industry in which the business operates, all businesses require fixed assets to trade and generate a profit. There are essentially two different types of fixed asset used by businesses, and these consist 0f tangible and intangible assets.
Tangible fixed assets
A tangible fixed asset has a physical presence and it is possible to see, touch and smell it. A tangible fixed asset is any long term asset a business will buy to generate an income. This tangible asset may generate income directly or indirectly. A fixed asset used for manufacturing products to sell generates income directly where as something like property or warehouse generates income indirectly.
Tangible fixed assets are typically categorised in specific groups such as plant and machinery, motor vehicles, land and buildings and fixtures and fittings. Specific examples of fixed assets include computers, chairs, desks, machinery, large tools, cars and commercial vans.
Cars and motor vehicles can be recorded on the balance sheet as fixed assets. Many businesses have cars on their fixed asset register although I doubt many are fortunate enough to own the Lotus Elan sports car, as pictured below.
When a business buys a tangible asset the cost is capitalised in the financial records by posting it directly to the balance sheet. The double entry is to debit the fixed asset code and credit the bank account code. When a business purchases an asset there is no effect on the profit and loss account and the business will not get tax relief on the purchase price.
It is important for all businesses to keep control over their assets and this is done via the fixed asset register. The fixed asset register is simply a list of the fixed assets owned by the business. The fixed asset register records details about the fixed asset, the date the fixed asset was purchased, the cost of the fixed asset and the net book value of the fixed asset, which is calculated as the cost less the accumulated depreciation.
The fixed asset register is an important schedule and is one that many business owners overlook. It is important for a business to know what assets are currently being used in the business, the physical state and condition of each fixed asset and where each fixed asset is located. Most employees are honest and would never steal from the business, however there are some unscrupulous employees that would steal so you need to do everything you can to stop this happening.
Most tangible fixed assets will gradually lose value over time as they are used in the day to day running of the business. An exception to this is a piece of land, which usually appreciates in value. It should be noted that some land does lose value, although this is rare in the real world. Land that loses value includes mines and oil fields which lose value as the minerals are excavated. A further fixed asset that rarely loses value over time is property, which is usually kept in a state of good repair so it holds its value.
Many businesses own and use computers. Here we have the Sony Vaio notebook which is a very good machine.
The reduction in the value of a fixed asset is a business expense, which is commonly known as depreciation, and charged to the profit and loss account. There are no hard and fast rules on calculating depreciation and it is often a subjective exercise. Depreciation is not a tax allowable expense and it is added back to the taxable profits when calculating the tax charge.
A business will, however, get tax relief on the reduction in value on some fixed assets by way of capital allowances. Capital allowances are calculated using predetermined rules and rates advised by the taxman, and these are deducted from taxable profits in calculating the tax charge.
Intangible fixed assets
An intangible fixed asset has no physical substance and it is not possible to touch or feel it, however an intangible fixed asset will still help to generate and income for the business. Examples of intangible fixed assets include goodwill, patents and licences.
An intangible fixed asset is treated much the same as a tangible fixed asset. An intangible fixed asset is recorded in the financial records at cost which is then reduced over the passage of time. The reduction in value of an intangible fixed asset is known as amortization which, just like depreciation, is a business expense in the financial statements.
A brand name is an intangible fixed asset that can be used to generate sales. The Pepsi name is worth millions and it is only right this brand name is capitalized on the balance sheet as an intangible fixed asset.
Unlike depreciation which can be calculated however the business sees fit, the way in which the amortization charge is calculated is dictated by the Accounting standards and all companies must comply with this. Goodwill amortization is a tax deductible expense and is deducted from the taxable profits when calculating the business tax liability.
It is not possible for an intangible fixed asset to get stolen and since a business is highly unlikely to have a great number of intangible fixed assets there is no need to maintain a detailed intangible fixed asset register. Even though a detailed intangible fixed asset register is not required it is important the business keeps a record of all intangible fixed assets that states the cost and the accumulated amortization.
In the real world very few businesses will have an intangible fixed asset so they are quite rare. This is totally the opposite of tangible fixed assets, whereby all businesses will have some kind of tangible fixed asset or another.
Fixed assets are a very important resource for businesses it is an area that should be properly controlled and managed. At any given time every business owner should know what fixed assets are in the business, the condition of the fixed assets, where the fixed assets are located and when the fixed assets need replacing.