An Easy Guide to Understanding Fixed Assets
One of a business’ most valuable resources is its fixed assets. Fixed assets may also be referred to as tangible, non-current, or long-term assets, but each term means the same thing: these are assets that will be of value longer than a year, to support the continued and long-term operations of the business. These assets are not readily converted into cash and will not be sold to customers during the normal course of business operations.
Examples of fixed assets include land, equipment, buildings, motor vehicles, computers, office equipment, furniture, and leasehold improvements. Note that inventory would not be considered a fixed asset because it is intended to be sold — or made into something that will be sold — to customers.
How to Determine a Fixed Asset
Fixed assets should appear on the company’s balance sheet if two conditions are met. The company must:
- Receive value from the asset.
- Be able to measure the value of the asset.
The first step is a revenue generation test. The asset must generate revenue for the company; for example, a piece of equipment owned by a company but is not currently in use might fail this test. Think about a piece of outdated equipment in storage — in its heyday it helped produce income, but today it is either not in use, doesn’t work, or cannot be sold, so it wouldn’t be considered a fixed asset.
The second test can be satisfied when a company purchases an item. The transaction should clearly record the value. A fixed asset that appears on the balance sheet is the book value (historical cost/purchase price – depreciation). Equipment given to a small-business owner as a gift would not appear on the balance sheet and would fail this test because there is no historical cost.
Fixed assets are tax deductible. Additionally, depreciation allows companies to lower their tax liability. For example, if a company purchases a machine that is expected to be in use for 25 years, it can spread the costs over the lifetime of the asset. The annual depreciation is equal to the cost of the machine divided by its estimated life.
- Cost of the machine: $100,000
- Estimated life: 25 years
- The annual depreciation would be ($100,000/25) = $4,000.00.
The $4,000 will be shown as an expense for the company on the income statement annually for the next 25 years.