Meaning and Purpose:
Fixed assets are defined as part of assets with an economic life of more than 12 months and are acquired for a particular amount or more as per company policy. These are capitalized and depreciated for financial statement purposes.
Fixed assets include tangible assets such as land, buildings, equipment, plants, and machinery. When these assets are purchased for business use, fixed assets capitalization policy should be followed.
A fixed assets capitalization policy outlines the standard procedures and guidance on recording these assets to the company’s books of accounts. The policy establishes the method of maintaining fixed assets information and capitalization amount to determine the fixed assets.
The important point is to note that meaning and purpose also forms part of fixed assets capitalization policy, but here we will discuss other important contents as below:
1) Maintenance of Fixed Assets List
An administrative officer maintains a fixed asset list. The Board of Directors shall review it at the close of the financial year to ensure that documents are updated and accurate.
The various particulars that should be contained in the worksheet of each asset on the list of the fixed assets are:
- Description of asset
- Assigned asset number
- Asset category
- Asset’s cost or acquisition value
- Asset’s salvage value
- Estimated useful life of assets.
- Date on which asset was purchased and placed in service
2) Capitalization thresholds, methods and procedure
Capitalization policy devises a threshold for determining whether assets are expensed or capitalized. The threshold is based on the cost of assets, say tangible assets bought above $1000 would be capitalized.
Fixed assets are recorded at historical cost on the date acquired. Cost includes secondary costs such as shipping and delivery costs, installation costs, and other costs necessary to bring to present condition for use.
The method also states that the assets above 12 months of useful life are capitalized irrespective of acquisition or production cost.
3) Useful Life
The period during which the fixed assets provide benefits is called useful life. The asset’s useful life is estimated as per various physical factors such as physical wear and tear and technological changes, which impact the economic benefits capacity of the fixed assets.
For instance, the useful life can be estimated as per general business norms as:
4) Depreciation Method
As per accounting standards and conventions, several methods can be used to depreciate fixed assets.
Various methods include a straight-line method of depreciation, reduced balance method, double declining method, among others. The most commonly used are straight line and reduced balance methods of depreciation.
For instance, if the straight-line depreciation method is used, the fixed asset is written-off evenly over its useful life. The amount of depreciation is determined by dividing an asset’s cost reduced by the salvage value, if any, by its estimated life.
At the end of the asset’s useful life, the salvage value will remain in the case of the straight-line method of depreciation.
5) Record-keeping for compliances and audits
The four things necessary to be seen are authorization, record-keeping, safeguarding, and verification. It can be explained as under:
- Who has authorized to purchase the fixed assets?
- Invoices substantiating the purchase of fixed assets.
- Entries made in the ledger accounts
- What sorts of safeguard measures has been kept in place to protect asset from unnecessary tear or theft or any other damages.
- Proper paper trail on the purchases, repairs, renovations, use of asset by keeping the logs, etc.
- Generally, the records regarding fixed assets for audit compliance is kept for 8 years. However, this may differ as per various laws and regulations. The company may also frame policy on this regard.