What is a fixed asset?
In accounting, an asset is considered a fixed asset if it cannot be sold or liquidated, i.e: converted to cash, within a year’s time. These are long-term assets, in that they form part of the infrastructure of the organization. They are essential for the organization to carry out its operations effectively. Fixed assets can be tangible or intangible. Tangible assets are those which are physical like buildings. Intangible assets are those which are not physical, like goodwill and copyright.
Why are they important?
Fixed assets are part of the infrastructure that is the reason why they are important. Without fixed assets, the business cannot flourish. The fixed assets play an important role in assessing the health of a business. Investors would look at the fixed assets a business has and its value before they take any investment related decision. A lender who has to give a loan to the business would estimate the value of the fixed assets before sanctioning the loan and fixing its amount. This is because, in case of any default, the lender can sell the fixed assets to recover his costs.
Examples of fixed assets
Some examples of fixed assets are:
- Office equipment and machinery
- Office furniture
- Vehicles owned by the company
- Intangible fixed assets like trademarks, copyright, and patents.
Depreciation of fixed assets
The value of an asset reduces over a period of time. This happens as the asset is used and also due to the aging of the asset. This is known as depreciation. The value of depreciation has to be accounted to get its real value. This is always recorded in the balance sheet and other statements. Throughout the life of the asset, its value keeps getting depreciated until it is replaced or sold. The final value of the asset is its salvage value. In some cases, the asset may have to be scrapped, in which case it is written off in the balance sheet.
Fixed assets like land, however, do not depreciate, as they do not age or lose value over a period of time. When it comes to intangible assets, they are amortized, which is nothing but reducing the value of the intangible asset over a period of time.
Accounting of fixed assets
A fixed asset is purchased to manufacture or produce the product or to carry out the service. It may also be given to a third party. The cash flow statement is used to record the purchase and disposition of fixed assets. When a fixed asset is purchased by a business, it is recorded as a cash outflow. When the fixed asset is sold, it is shown as a cash inflow. Every asset has a book value. When the price of the asset falls below its net book value, it is then written down. An asset may be finally disposed by selling it off for cash or it may be scrapped if it is obsolete and serves no purpose. In such cases, the fixed asset is written off.
Fixed assets are long-term resources for the organization, which cannot be sold quickly. They are part of the infrastructure and are essential for the operations of the business.