What are fixed assets?
Fixed assets are physical or tangible assets a company owns and uses in its business operations to provide services and goods to its customers and help drive income. These assets, which are often equipment or property, provide the owner with long-term financial benefits. A business is expected to keep and use fixed assets for at least one year. The value of fixed assets declines as they are used and age — except for land — so they can be depreciated. Fixed assets are often converted into cash at the end of their life cycle.
When a business acquires a fixed asset, it is included in financial reporting, usually as PP&E on the balance sheet. Fixed assets are initially capitalized on a company’s balance sheet and periodically depreciated. Depreciation is found on financial statements like balance sheets, cash flow statements, and income statements.
It is common for a business to lease fixed assets. While the business does not own that asset, leased assets act as fixed assets. Under ASC 842, the recent lease accounting standard issued by the Financial Accounting Standards Board (FASB), a lessee must record assets and liabilities for leases with lease terms of more than 12 months.
Why are fixed assets important?
Fixed assets are essential for several reasons. They can:
- Help a company provide services and goods to customers and generate revenue
- Educate creditors and investors on the financial health of a company
- Indicate that a business may be in a high-growth mode
What are examples of fixed assets?
The most common types of fixed assets include:
- Software
- Vehicles
- Machinery
- Tools
- Land
- Buildings
- Furniture
- Computer equipment
Intellectual property like patents, copyrights, and trademarks can also be considered fixed assets. While they are not physical assets, they are intended to help generate revenue.
When classifying fixed assets, what may be considered a fixed asset for Company A might not be a fixed asset for Company B. For example, a tractor supply company would classify the tractors as inventory. A commercial farmer would classify them as fixed assets.
Therefore, when classifying and calculating fixed assets, take into account the type of business in which the client operates.
How do you calculate fixed assets?
You calculate fixed assets by determining their actual value. This is achieved by calculating the net fixed assets, a metric that takes the purchase price of the fixed assets — as well as any improvements — and deducts the accumulated depreciation to obtain the true value. Below is a formula for determining net fixed assets.
Formula A: Gross fixed assets - accumulated depreciation = net fixed assets
To determine how much of the net assets the client owns, consider an alternative formula that eliminates the fixed asset liabilities, which are the debts and financial obligations the company owes on those assets.
Formula B: (Total fixed asset purchase price + improvements to the assets) - (accumulated depreciation + fixed asset liabilities) = net fixed assets
What is the difference between fixed assets and current assets?
The differences between fixed assets and current assets are as follows:
- Fixed assets are a type of noncurrent asset that are depreciable and illiquid. When a fixed asset is sold, it is capital profit or loss for the company. It is expected that a business will keep and use fixed assets for at least one year — often referred to as its “useful life.”
- Current assets are liquid and include items such as inventory, cash, and cash equivalents. When a current asset is sold, it is a revenue profit or loss for the company. Current assets are not depreciable and are shorter term, meaning less than one year.
What is the life cycle of fixed assets?
The fixed asset life cycle is a series of stages that starts with the client acquiring an asset and ends when they dispose of it. It includes four key stages:
- Acquisition. This is the first stage of the life cycle. Purchasing a fixed asset, like new machinery, is a common way to obtain a fixed asset. However, some clients may use internal workers to build their assets. In this case, consider how much of the workers’ salary to include in the asset's cost.
- Depreciation. During the second stage, the value of fixed assets — like machinery and office equipment — declines as they are used and age, except for land. This means fixed assets can be depreciated. An asset’s useful life, the salvage value, and depreciation method— that is, straight-line, declining balance, units of production, or sum-of-the-years’ digits — are factors to consider when calculating depreciation.
- Maintenance and repairs. After some time of use, most fixed assets will need repairs and maintenance. Consider whether to capitalize or expense the work, especially if it is extensive and boosts the asset’s value.
- Disposal. This is the final stage. In this stage, fixed assets are often converted into cash. There are, however, several ways a client can dispose of a fixed asset. They could sell, donate, or replace it with a similar, newer asset.
What is fixed asset accounting?
Fixed asset accounting is the process of entering the asset’s purchase cost, periodically depreciating the cost over the asset’s useful life as it declines in value, eventually disposing of the asset and removing it from the books.
What is a fixed asset turnover ratio?
A fixed asset turnover ratio is an efficiency ratio used to determine how successfully a company generates sales from its fixed assets. It is most useful among companies that require a large capital investment to conduct business, like manufacturers.
How do you calculate the asset turnover ratio?
You determine the fixed assets turnover ratio with the following formula:
Net annual sales ÷ (Gross fixed assets − accumulated depreciation) = Fixed asset turnover ratio
What is a good asset turnover ratio?
A ratio greater than one indicates a company is selling its fixed assets at a good rate. On average, most businesses have a turnover rate between five and 10. A higher turnover rate means greater success in its ability to manage fixed asset investments. However, there is no specific ratio or range that defines a “good” asset turnover ratio. Instead, companies’ turnover ratios are very industry specific, and other factors must be considered. For example, if a company’s competitors have ratios of 2.25, 2.5, and 3, its ratio of 3.75 is high compared to its rivals.
In addition, these are other factors that can influence results:
- Heed caution if a company uses accelerated depreciation. It could result in the turnover ratio being higher than it should be.
- Compare a client’s current ratio with previous periods or the ratios of industry standards or comparable businesses. This method will help better determine if they are efficient at generating revenue on such assets.
- Avoid including intangible assets in the denominator. It can distort the results.
