Fixed assets are a key part of any business and need to be managed carefully in order to maximise their value. This guide provides an overview of the main considerations when managing fixed assets, including accounting for them, insuring them and disposing of them.
Types of Fixed Assets
There are many different types of fixed assets, but the most common are:
- Buildings: these can include office buildings, warehouses, factories and shops.
- Machinery: this can include production equipment, vehicles and tools.
- Land: this can be either commercial or agricultural land.
- Furniture: this includes items such as desks, chairs and filing cabinets.
- IT equipment: this can include computers, printers and software.
Benefits of Fixed Assets
Information on a company’s assets is important in generating accurate financial statements, business valuations, and comprehensive financial analysis. These documents are used by investors and lenders to assess a company’s financial stability and whether or not to purchase shares in it.
Fixed assets also provide security for a company’s creditors in the event of insolvency. Creditors can claim back the value of any assets that have been used as collateral against a loan.
Lastly, fixed assets can be used to generate income through leasing or hiring them out to other businesses. This can provide a valuable source of revenue, which can be used to reinvest in the business or pay off debts.
Key Characteristics of Fixed Assets
There are several key characteristics of fixed assets, which include:
1. They are long-term investments: Fixed assets are not intended to be sold in the short-term, but are instead held for a long period of time in order to generate income.
2. They are not easily converted into cash: Fixed assets are not easily converted into cash, which means that they are not as liquid as current assets.
3. They are recorded at their historical cost or their current market value: Fixed assets are recorded in the accounts at their historical cost or their current market value, whichever is lower.
4. The proceeds from their sale are used to reduce the asset’s value in the accounts: When a company disposes of a fixed asset, the proceeds from the sale are used to reduce the asset’s value in the accounts.
5. They are depreciated over time: All assets depreciate over time, which means that their value decreases. This can impact negatively on a company’s accounts if the asset is not replaced.
Difference between Fixed and Current Assets
Fixed assets are long-term investments that a company uses to generate income, while current assets are short-term assets that are used to run the day-to-day operations of the business.
Current assets include things like cash, inventory and accounts receivable, while fixed assets include things like buildings, machinery and land.
Fixed assets are not easily converted into cash, while current assets are more liquid and can be turned into cash quickly if necessary.
Fixed assets are recorded on the balance sheet at their historical cost or their current market value, whichever is lower. Current assets are recorded at their historical cost or their current market value, whichever is higher.
When a company disposes of a fixed asset, the proceeds from the sale are used to reduce the asset’s value in the accounts. When a company disposes of a current asset, the proceeds from the sale are recorded as income in the accounts.
Tips for Managing Fixed Assets
There are several things that companies can do to manage their fixed assets effectively, which include:
1. Identify all assets: The first step is to identify all of the company’s assets, both tangible and intangible. This will give you a clear picture of what you have and where it is located.
2. Assign responsibility: Once you have identified all of your assets, you need to assign responsibility for each one to a specific member of staff. This will help to ensure that assets are properly cared for and accounted for.
3. Create an inventory: An inventory should be created for all assets, which should include the asset’s description, location, value and date of purchase. This will help you keep track of your assets and their value.
4. Insurance: All assets should be insured against loss or damage. The cost of insurance should be included in the accounts as an ongoing expense.
5. Disposal: When an asset is no longer needed, it must be disposed of properly. This usually involves selling it or scrapping it. The proceeds from the sale should be deducted from the asset’s value in the accounts. If the asset is scrapped, its value should be written off completely.
Accounting for Fixed Assets
Fixed assets must be recorded in a company’s accounts in order to produce accurate financial statements. The cost of each asset should be spread over its useful life using the straight-line method. This means that the cost is allocated evenly across each year of the asset’s life.
The value of a fixed asset can also change over time due to depreciation (a reduction in value due to wear and tear) or appreciation (an increase in value). These changes should be reflected in the accounts so that the financial statements accurately reflect the current value of the assets.
Determining the Value of Fixed Assets
The value of fixed assets can be determined using a variety of methods, which include:
1. Cost: The cost method is the most common method of determining the value of fixed assets. This method uses the historical cost of the asset to determine its value.
2. Depreciation: The depreciation method is a method of determining the value of fixed assets that uses the estimated useful life of the asset to determine its value.
3. Market: The market method is a method of determining the value of fixed assets that uses the current market value of the asset to determine its value.
4. Replacement cost: The replacement cost method is a method of determining the value of fixed assets that uses the estimated cost to replace the asset to determine its value.
5. Other methods: There are other methods of determining the value of fixed assets that can be used, such as the book value or the fair market value.
Risks of Fixed Assets
There are several risks associated with fixed assets, which include:
1. Theft: Fixed assets can be stolen, either by employees or external criminals. This can lead to a loss of income and increased insurance premiums.
2. Damage: Fixed assets can be damaged through accidents, natural disasters or wear and tear. This can lead to repair costs, replacement costs or a reduction in the asset’s value.
3. Loss: If a fixed asset is lost, for example if it is destroyed in a fire or stolen and not recovered, the company will have to bear the cost of replacing it.
4. Depreciation: All assets depreciate over time, which means that their value decreases. This can impact negatively on a company’s accounts if the asset is not replaced or its value is not accounted for.
Depreciation of Fixed Assets
Depreciation is the process of allocating an asset’s cost over its useful life. This is done in order to reflect the fact that an asset’s value decreases over time.
There are several methods of depreciation, which include:
- Straight-line method: Under this method, an asset’s cost is allocated evenly over its useful life.
- Accelerated method: Under this method, an asset’s cost is allocated more in the early years of its life and less in the later years.
- Declining balance method: Under this method, an asset’s cost is allocated more in the early years of its life and less in the later years. However, the rate of depreciation is not constant, but decreases over time.
- Sum-of-the-years’-digits method: Under this method, an asset’s cost is allocated more in the early years of its life and less in the later years. However, the rate of depreciation is not constant, but decreases over time.
- Units-of-production method: Under this method, an asset’s cost is allocated based on the number of units that it produces.
The straight-line method is the most commonly used method of depreciation.
When to Depreciate Fixed Assets
Depreciation should be recorded in the accounts when there is a reduction in the asset’s value due to:
1. Wear and tear: Over time, all assets will suffer from wear and tear, which will reduce their value.
2. Obsolescence: Assets can become obsolete if they are no longer used or needed by the business.
3. Depletion: Assets can be depleted if they are used up or consumed by the business.
4. Diminution in value: Assets can lose their value for other reasons, such as changes in market conditions.
Non-Depreciating Fixed Assets
There are some assets that do not depreciate in value over time, which include:
1. Land: Land is a non-depreciating asset because its value does not decrease over time.
2. Intangible assets: Intangible assets, such as goodwill and patents, are also non-depreciating assets.
3. Financial assets: Financial assets, such as stocks and bonds, are also non-depreciating assets.
Financing Considerations for Fixed Assets
There are several financing considerations that need to be taken into account when acquiring fixed assets, which include:
1. The cost of the asset: The cost of the asset will need to be considered when deciding how to finance it.
2. The expected life of the asset: The expected life of the asset will need to be considered when deciding how to finance it.
3. The expected return on the asset: The expected return on the asset will need to be considered when deciding how to finance it.
4. The risk associated with the asset: The risk associated with the asset will need to be considered when deciding how to finance it.
5. The impact on cash flow: The impact on cash flow will need to be considered when deciding how to finance it.
6. The tax implications: The tax implications will need to be considered when deciding how to finance it.
7. Other factors: There may be other factors that need to be considered when financing fixed assets, such as the need for collateral.
Types of Financing for Fixed Assets
There are several types of financing that can be used to finance fixed assets, which include:
1. Debt financing: Debt financing can be used to finance fixed assets. This can be done through loans or lines of credit.
2. Equity financing: Equity financing can be used to finance fixed assets. This can be done through the sale of equity or the issuance of shares.
3. Leasing: Leasing can be used to finance fixed assets. This can be done through operating leases or capital leases.
4. Other types of financing: There are other types of financing that can be used to finance fixed assets, such as grants or subsidies.
5. Self-financing: Self-financing can be used to finance fixed assets. This can be done through the use of savings or the sale of other assets.
Insuring Fixed Assets
Fixed assets should be insured against loss or damage. This will protect the business from the financial impact of losing or damaging its fixed assets. The type of insurance that is needed will depend on the type of asset and the risks that it faces.
1. Asset-specific insurance: Asset-specific insurance is insurance that covers a specific asset. This can be done through the purchase of an insurance policy that covers the asset.
2. Business interruption insurance: Business interruption insurance is insurance that covers the loss of income that a business suffers when its operations are interrupted. This can be done through the purchase of an insurance policy that covers the business.
3. Property insurance: Property insurance is insurance that covers the physical property of a business. This can be done through the purchase of an insurance policy that covers the property.
4. Product liability insurance: Product liability insurance is insurance that covers the liability of a business for injuries or damages that are caused by its products. This can be done through the purchase of an insurance policy that covers the products.
5. Professional liability insurance: Professional liability insurance is insurance that covers the liability of a business for injuries or damages that are caused by its professional services. This can be done through the purchase of an insurance policy that covers the professional services.
Dealing with Fixed Assets in Insolvency
Fixed assets can be dealt with in insolvency by:
1. Selling the assets: The assets can be sold in order to generate cash for the business.
2. Leasing the assets: The assets can be leased in order to generate income for the business.
3. Transferring the assets: The assets can be transferred to another party, such as a family member or friend.
4. Abandoning the assets: The assets can be abandoned if they are no longer needed by the business.
5. Self-financing: Self-financing can be used to finance fixed assets. This can be done through the use of savings or the sale of other assets.
6. Borrowing: Borrowing can be used to finance fixed assets. This can be done through the use of loans or the issuance of bonds.
7. Equity financing: Equity financing can be used to finance fixed assets. This can be done through the sale of shares or the issuance of equity.
8. Other methods: There are other methods of financing fixed assets that can be used, such as the use of government grants or the use of private equity.
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