Acquiring and Accounting for Fixed Assets
Acquisition of Fixed Assets
A business normally needs fixed assets to enable it to earn profits. A manufacturing business requires buildings and heavy machinery, while a service supplier is likely to need office space, furniture and computers. Most businesses also use intangible assets such as goodwill, patents or trademarks. The choice of which fixed assets to buy is a very important business decision.
Examples of Fixed Assets and Their Valuation
The assets of a business are categorized in the accounts as fixed assets or current assets. The fixed assets are the land, buildings, plant and equipment used in the conduct of the business. These fixed assets may be tangible assets such as machinery or intangible assets such as patents or trademarks. The valuation of intangible assets may be particularly difficult.
Understanding Intangible Assets
Intangible assets may take many forms. When an intangible asset is built up within a business over time, it often does not appear on the balance sheet at all because no expenditure was incurred for its acquisition. One example is goodwill when it is developed within the business rather than being bought through acquisition of another business. Other intangible assets such as patents may be developed through research and development and the costs of their development can be capitalized and shown on the balance sheet.
Examples of Current Assets
Current assets are the circulating capital such as cash, debtors and inventory that keep the business going in its day-to-day operations. Inventory is sold and the customer becomes a debtor to the business. When the debt is collected, the business holds cash with which to pay liabilities as they fall due. The ability to pay debts as they arise is important for continuing the business as a going concern. The business must monitor the level of current assets compared to current liabilities.
What Is the Difference Between Current and Noncurrent Assets?
The difference between fixed and current assets has sometimes been a subject of dispute in company law. Fixed assets are the assets that are used to earn the profits of the business and are not normally readily convertible into cash. Current assets could be described as those assets that may be converted into cash within a relatively short period such as one year.
Generally Accepted Accounting Principles for Cost Capitalization
There are specific accounting rules in relation to what should be capitalized as a fixed asset and what is regarded as an expense that should be charged to the income account. The categorization of expenditure as fixed asset expenditure is determined by accounting standards and by the law of a particular country.
How Inflation Affects the Market Value and Book Value of Assets
Assets are generally recorded in the accounts at their historic cost; in other words, the cost at the time when they were acquired. In most places, however, inflation of the currency occurs to a greater or lesser extent. Therefore, accounting standards provide for the possibility of revaluing assets on the balance sheet to reflect their worth at the time a particular set of financial statements is prepared rather than their cost on acquisition.
A Corporate Capitalization Policy for Fixed Assets
The criteria used by enterprises to capitalize items as assets on their balance sheet are considered significant enough to be documented and disclosed as part of Sarbanes Oxley compliance. The precise criteria for capitalizing assets as opposed to treating items as expenses are important for taxation purposes.