What is a Fixed Asset ?
Fixed Assets are business purchases which will be used by the business for a few years. Examples are machinery, vans and computers.
To be classified as a Fixed Asset, rather than an Expense, the purchase would tend to have significant value. $500 is a suggested minimum, and different businesses will have different 'capitalisation' policies.
Fixed Assets are classified as Assets in the Balance Sheet, not Expenses in the Profit and Loss Account.
Is it possible to add an expense category that allows me to post an item as an asset? For example the purchase on expenses of a computer.
I'm going to assume you want to record the computer as a fixed asset, so the easiest way to resolve this would be to create a non stock item to represent this computer/these computers.
When you set up the item you will need to setup and select the asset account you want to use to record the fixed assets of this type. If you intend to dispose of this computer at some point in the future then I would set up the sales income account to an "other income" account (i.e. sales of capital equipment).
When you use this item on a cash purchase or a bill (supplier/purchase invoice the accounting will be correct inasmuch as the Fixed Asset account will be debited and the Bank/Accounts Payable/Purchase Ledger will be Credited. Also useful, you can attach Memo's to this unique item and keep a history including documents.
Some useful background on the treatment of Fixed Assets in your accounts.
I’m not a qualified accountant so you should always check with your accountant before implementing any of this. But because I get so many questions about this I thought I run through some of the basics just to give you enough insight to ask the right questions and understand the answers. I’m going to explain fixed assets and how your accounts are affected by:
- The depreciation of a fixed asset
- The purchase of a fixed asset
- The sale of a fixed asset for a loss or a gain
There are two types of fixed assets:
- Fixed assets you can depreciate - these exist for more than one year and are commonly used in the operation of your business (i.e. computers, equipment, vehicles and buildings.)
- Fixed assets you cannot depreciate, these typically have a useful lifespan of less than a year.
Depreciation is the gradual transfer of the original cost of a Fixed Asset from the Balance sheet to the Profit and Loss account. The transfer is usually done by a Journal.
It could be said that Depreciation is "Expensing" a Fixed Asset - ie. a percentage of the cost of the Fixed Asset becomes an Expense, and the Fixed Asset then has a lower value on the Balance Sheet. It is usually a simple calculation which is usually made once a year.
So let’s look at the basics of depreciation and how we calculate the value of a fixed asset.
I like to think of depreciation as basically a cost recovery, it allows you offset the expense you incurred from purchasing the fixed asset against your income, thus reducing your profits and lowering the amount of tax you pay.
Because depreciation is based on the value of fixed assets, you need two Asset accounts to accurately track and calculate the value of a fixed asset. These accounts are:
- The fixed asset account - where the original cost of the fixed asset is recorded (Debited)
- The accumulated depreciation account - this account contains the amount by which the fixed asset has been depreciated.
Rather than decreasing (Crediting) the fixed asset account directly, accountants put depreciation expense in the offset accumulated depreciation account. You cannot tell from the balance sheet how much depreciation was recorded in the period as this amount is recorded (Debited) in an Expense account in the P&L.
So it follows that when you depreciate a fixed asset you use a General journal to debit the P&L depreciation account and credit the accumulated depreciation account. Therefore subtracting (2) from (1) gives us the current value of the fixed asset. The result of which is used to calculate the value of the fixed asset at the time of:
- disposal or retirement
- the commencement of the next depreciation period
I’m not going to get into the methods by which you calculate how much to depreciate an assets here. You should always talk to your accountant about these methods.
Now let’s take a look at what happens when you buy and sell a fixed asset.
This is very straightforward, when you make the purchase you are manipulating the balances of the Asset accounts by exchanging cash (Asset) for the value of the fixed Asset. We’re debiting one asset account and crediting another.
When you purchase the Fixed Asset you just need to be careful that you Debit the expense to an Asset account so as it doesn’t show up on the P&L for the reasons I have just explained. You’re basically setting up a one off non stock item Item whose expense points to the fixed asset account and income points to an Other Income account.
When it comes to selling the fixed asset, remember you are moving it off the balance sheet and getting cash in return. So in this case we are crediting the Other Income Account and debiting the fixed asset account. To calculate the value and therefore the selling price of the fixed asset you calculate the residual value of the fixed asset by subtracting the value in the accumulated depreciation account from the balance in the fixed asset account (obviously related to that item).
Other stuff you might want to know...
Straight Line Depreciation
For example, a computer costs $1,000, and is expected to last 4 years, ie. an annual depreciation rate of 25%. On a straight line method the annual depreciation is $250, which is transferred to the Profit and Loss Account from the Balance Sheet every year for 4 years. So after 1 year, the Balance Sheet value becomes $750, and the $250 has been charged as Depreciation to Profit and Loss. In the second year, the computer depreciates to $500, and another $250 is charged to Profit & Loss.
Reducing Balance Depreciation
Another depreciation method is the reducing balance method. This method may be suitable when the Fixed Asset will be gradually losing its value, but its useful life cannot be precisely estimated. For example a van may cost $8,000. In the first year 25%, ie $2,000 could be depreciated, leaving a balance of $6,000. In year 2, 25% is depreciated from the reduced balance of $6,000, ie. $1,500, leaving a balance of $4,500, and so on.