Fixed Assets: What are they and why are they important in modern accounting practice?
Fixed assets are long-lived assets that enable production of the goods and services that generate income for enterprises. “Fixed”, as an epithet for these assets, connotes the assets’ relative permanence; it does not express any notion that the assets are immovable. Besides being relatively permanent and being used in an enterprise’s operations, fixed assets are not intended to be sold. No enterprise will sell or expend these assets within any one year; the enterprise retains these assets indefinitely for business operations.
On account of their bodily substance, fixed assets are classified as tangible long-lived assets. They include real estate, machinery, equipment, furniture, fixtures, fittings, leasehold improvements and similar items categorized as Property, Plant and Equipment (PP&E). Natural resources, such as mineral deposits and timber, are tangible long-lived assets but are not regarded as fixed assets. Intangible long-lived assets include goodwill, patents, copyrights, franchises and trademarks; they have no physical substance but they have future economic value because of their inherent rights. International Accounting Standards (IAS) and the subsequent International Financial Reporting Standards (IFRS) govern modern accounting practice. Reissued in 2003, IAS 16 stipulates that PP&E are to be recognized as fixed assets only if “it is probable that future economic benefits will flow to the entity” and “the cost of the asset can be measured . . . reliably”.
Initially, the value of any item of PP&E is its cost. Subsequently, the value is measured on the basis of cost or revaluation and is subject to periodic depreciation throughout the asset’s useful life. The total cost of any fixed asset is the cash, or equivalent, paid to acquire the item and get it to the designated location in the desired condition. Therefore, this cost includes the asset’s purchase price, trade discounts, import duties, handling charges and installation charges.
In modern accounting practice, fixed assets are important because of their purpose, value and longevity. Their primary purpose, in the production of goods and services, supports most enterprises’ primary objective of earning profits and increasing the owners’ wealth. To attain this objective, the enterprises’ management will scrupulously apply accounting’s matching concept since fixed assets conventionally generate revenue for periods exceeding one year.
As repositories of monetary value, fixed assets generally account for a significant proportion of organizations’ total assets. This is principally because of the accounting practice of classifying items of a minimum value – or greater – as fixed assets. Fixed assets registers show that many fixed assets have high initial unit costs. The values of these assets influence the related accounting and auditing efforts. When revalued favorably, fixed assets improve the organizations’ financial position. Additionally, depreciation allowances yield tax advantages that beneficially affect profit.
Fixed assets’ longevity influences the periodic demands for human and accounting resources. Even at the end of the assets’ useful lives, particular accounting procedures mark this event. Appropriate accounting software gives business leaders the opportunity to employ best practices in accounting for fixed assets.