Fixed assets are a key resource for small businesses and can represent a major portion of the net worth captured on the balance sheet. Recording, maintaining, and reconciling the fixed asset account is vital because errors can lead to inaccurate valuation of a business or incorrect tax reporting — potentially affecting investors, lenders, and agencies like the IRS.
What are Fixed Assets?
A fixed asset is a resource purchased for business use that has long-term value. As the asset is used and decreases in value, it depreciates so that its current estimated value is reflected on the financial statements. Examples of fixed assets include:
- Equipment (e.g. office equipment, machinery, appliances, computers, tools, and vehicles)
- Leasehold improvements (improvements to rented property, paid for by the renter, that transfer to the landlord at the end of the lease)
Recording Fixed Assets
Fixed assets are recorded at their original cost, which includes more than just the purchase price. Additional costs include expenses to acquire, install, and prepare the property or equipment for use. For example, say a business purchases a parcel of land on which it constructs a new commercial building. The expenditure to prepare the land for construction would be included in the price of the building when it is recorded as a fixed asset.
Sometimes fixed assets are purchased in a lump-sum purchase — for example, the purchase of a building and the land it’s built upon. The land and the building must be separated because while land is not depreciable, the building will depreciate. The cost can be separated and allocated either by appraisal value, if available, or by a ratio provided by the county or municipal tax assessor.
Events altering fixed asset inventory:
- New purchases
- Extraordinary repairs that extend the life of the asset
- Discarding or retiring property and equipment
- Selling property or equipment
- Exchange or trade for similar asset
- Asset impairment
Tracking Fixed Assets
Once an asset is purchased and recorded, it must be tracked. All fixed assets should be permanently tagged with a fixed asset tag that contains a serial number. The number should correspond to a log book or the fixed asset module (the subsidiary ledger) of the accounting system.
Each fixed asset’s physical location should be documented and any moves within or outside the facility should be recorded. Any sales, new acquisitions, or salvages should also be recorded to ensure fixed asset inventory is up to date.
In the event of an IRS audit, fixed assets need to be substantiated in support of the depreciation deduction. (The initial recording of an asset is the basis for depreciation and the depreciation expense directly affects net income or loss, as well as assessed tax liability.) Also required is substantiation of any disposals of assets to ensure depreciation does not continue for assets no longer owned by the business and that any gain or loss on a sale is captured.
Reconciling Fixed Assets
Maintaining accurate fixed asset records is twofold. First, reconcile the general ledger fixed asset account to the fixed asset subsidiary records or fixed asset listing. The general ledger balance can be verified with this equation:
Beginning fixed asset balance
+ Additions for the period
- Disposals for the period
Ending fixed asset balance
The ending general ledger balance should equal the listing of all current fixed assets maintained in the subsidiary ledger. Any differences should be researched and corrected.
Second, the physical inventory of fixed assets should be verified against the fixed asset listing to ensure all assets are accounted for and present. Fixed assets should be traced from their location to the books and fixed assets on the books should be traced to their physical location. This is not usually done in total each month, but a test sample can be chosen randomly periodically. Then a full inventory should be done on an annual basis.