Fixed Assets

Definition

Fixed assets are long-term tangible and intangible resources that a company uses in its operations to generate income. They are not expected to be converted into cash within a year and include items like buildings, machinery, land, and patents. Understanding fixed assets is crucial as they represent significant investments for a business and impact financial statements through depreciation and impairment.

5 Must Know Facts For Your Next Test

1. Fixed assets are recorded on the balance sheet at their historical cost, which includes purchase price, installation costs, and any other expenses necessary to prepare the asset for use.
2. Unlike current assets, fixed assets are depreciated over time to reflect their usage and wear, which affects the net income reported on the income statement.
3. Some fixed assets, like land, do not depreciate because they have an indefinite useful life, while others like machinery will have defined useful lives and require regular assessment.
4. When a fixed asset is sold or disposed of, it can result in either a gain or loss depending on its sale price compared to its carrying value.
5. Intercompany transactions involving fixed assets can complicate financial reporting, as they may need to be adjusted to eliminate unrealized profits in consolidated financial statements.

Review Questions

• How does depreciation affect the financial statements of a company with fixed assets?
  • Depreciation impacts a company's financial statements by reducing the book value of fixed assets on the balance sheet while also creating an expense on the income statement. This expense decreases net income, which affects retained earnings and overall equity. Understanding this relationship is important for assessing a company's financial health and investment potential.
• What accounting treatments are necessary when transferring fixed assets between related companies in intercompany transactions?
  • When transferring fixed assets between related companies, it's essential to recognize the fair value of the asset and eliminate any unrealized gains or losses during consolidation. Proper accounting treatments include adjusting the carrying amount of the asset in both companies’ books and ensuring that any profit from the transaction does not inflate the consolidated net income until realized through sale to an outside party. This maintains accurate financial reporting across entities.
• Evaluate how impairment testing of fixed assets can influence decision-making within a company’s management team.
  • Impairment testing provides critical insights into whether fixed assets are performing as expected or if their value has diminished due to changes in market conditions or operational performance. Management must act on this information by potentially writing down asset values, which can lead to significant financial implications. This evaluation helps guide decisions related to resource allocation, investment strategies, and operational efficiency, ensuring that management aligns asset utilization with long-term business goals.

Related terms

Depreciation: The systematic allocation of the cost of a tangible fixed asset over its useful life, reflecting the wear and tear of the asset.

Capital Expenditures: Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment.

Impairment:

A reduction in the carrying amount of a fixed asset when its market value falls below its book value, indicating that the asset may not generate the expected future cash flows.