A company’s balance sheet represents its financial health and position of it at a given time. Generally, a balance sheet is presently based on the accounting equation.
It represents the assets owned by a business entity, liabilities owed, and the business’s equity. However, the classified balance sheet focuses on representing the assets and liabilities in a more elaborated way.
The assets are further categorized as current and non-current assets. Similarly, the liabilities of a company are also segregated as current and non-current liabilities.
The current assets and liabilities are those that relate to the next 12 months period. Any asset that will last for more than a year and liability to become due in more than 12 months is recorded as a non-current part of the balance sheet.
Non-current assets of a business entity are divided into tangible and intangible assets. Tangible assets are also called physical assets, and these physical assets are fixed assets.
This article will articulate the classification, recognition, measurement, and calculation of the fixed assets in the balance sheet of any business entity.
What Are Fixed Assets?
Fixed assets can be defined as,
Fixed assets are tangible or physical assets of a company that are used in day-to-day operations for profit generation. Any asset that is expected to be consumed in more than one year is considered a fixed asset. Another condition for a fixed asset is that it should be physically present and can be touched.
Fixed assets are often referred to as capital assets. Many business entities record fixed assets under the line item of property, plant & equipment.
IAS 16 of International Accounting Standards defines property, plant & equipment as,
Property, plant, and equipment are non-current physical assets of a business operating the business and keeping it running.
Classification Of Fixed Assets
As discussed above, the fixed assets last for more than one year, and therefore, these assets are classified as Non-current assets or long-term assets in a classified balance sheet. All the property, plant, and equipment are classified as fixed assets other than the following:
- Any fixed asset held for sale (IFRS 5 Non-current assets held for sale and discontinued operations) will not be recorded in the balance sheet as a fixed asset.
- Any biological assets under IFRS 41 or mineral rights & mineral reserves will also not be recorded as a company’s fixed asset.
What Is Considered Fixed Assets
The most common examples of fixed assets of a company include the following:
- Computer equipment and software
- Furniture and fixtures
- Machinery and plant
There can be more fixed assets of a company depending on the nature of a business. For example, an airplane will be a fixed asset for an airline, and a bus will be a fixed asset for a transportation company.
When will an asset be recognized as a fixed asset for a company?
IAS 16.7 dictates the recognized standards for an asset to be defined under fixed assets of a business entity. According to it, the asset will be recognized when:
- There is a certainty that the fixed asset will help to generate profits or economic benefits for the business. These benefits must continue for more than 12 months
- The cost of the asset can be measured with reliability.
Unit Of Measure For Recognition
The accounting standard has not defined a fixed unit of measurement for the value of the fixed assets. However, it depends on the valuation model used by the business entity.
For instance, if a business entity uses a cost model, the accumulated depreciation will be deducted from the initial cost of fixed assets at regular intervals.
Carrying Amount Of The Fixed Assets
Any costs related to replacements of parts in fixed assets will be added to the cost to recognize the carrying amount of the fixed assets.
Similarly, the inspection costs for assessing any faults in the fixed assets are also recognized as the cost of fixed assets. However, recognition remains the same criteria as discussed above(economic benefit & cost ascertainment).
Measurement And Calculation
The fixed assets’ value is calculated at the time of acquisition which is known as initial recognition. Later on, the carrying amount is calculated in future financial periods. It is known as a subsequent measurement to initial recognition.
According to IAS 16.15, the initial recognition of a fixed asset is done on the cost. The initial cost includes all kinds of costs that are incurred to make the asset operational. Some costs that are realized as the initial recognition cost are as follow:
- The actual purchase cost of the asset
- Handling cost
- Transporation in
- Installation charges
- Repairs and fixtures, if necessary, to bring the asset into the functionality
- Fees of architects and engineers
- Any costs incurred for dismantling or removing the assets
- If the asset has been acquired on credit, any interest paid will also be recognized as part of the asset’s cost. (IAS 16.23)
Measurement Subsequent To Initial Recognition
Under the IAS 16, there are two permissible methods for measuring a fixed asset’s value after initial recognition.
As per IAS 16.30, a business entity can record the value of fixed assets in the balance sheet at the initial cost less any impairment and accumulated depreciation realized so far.
The revaluation method signifies that the fair value of the fixed asset will be calculated every time. The value less any depreciation and impairment will be recorded in the balance sheet of the business entity. The revaluation method is allowed only if fair value can be calculated with certainty.
Depreciation is calculated as a subsequent measurement to the initial recognition. We can define depreciation as the periodic allotment of the asset cost as an expense over the fixed asset’s useful life.
The depreciation on the fixed assets can be calculated by using different methods. We will discuss the straight-line method and decreasing balance method with examples.
Straight Line Method
Most business entities use the straight-line method for the valuation of the fixed assets in the balance sheet. The initial value of the fixed asset is divided into equal parts by dividing the total cost by the number of years of useful life.
Each amount is deducted from the fixed assets at the end of every financial period. Similarly, the same amount is charged to the expenses account and deducted from the gross margin.
Let’s see how to calculate the straight-line method.
The formula is
Let’s do this by example.
The cost of machinery is $20,000. According to the company’s estimates, the residual value will be $5,000. The estimated useful life of machinery is 5 years.
The annual depreciation expense will be calculated as:
Depreciation expense = (20,000 – 5000)/5
Depreciation expense = $3,000
The depreciation schedule under this method will look like this
|Year||Computation||Depreciation Expense||Accumulated Depreciation||Book Value|
|1||15000 * 1/5||$3,000||$3,000||$17,000|
|2||15000 * 1/5||$3,000||$6,000||$14,000|
|3||15000 * 1/5||$3,000||$9,000||$11,000|
|4||15000 * 1/5||$3,000||$12,000||$8,000|
|5||15000 * 1/5||$3,000||$15,000||$5,000|
The important thing to be noticed is that an asset’s residual value is not accounted for by depreciation. The reason is that residual value is the amount a company expects to recover at the disposal of the discarded asset.
Declining Balance Method
Under the declining balance method, a fixed percentage of the remaining value at the end of each year is calculated and deducted from the fixed asset.
The same amount is recognized as an expense in the income statement. The declining balance method is more commonly used for tax purposes in different business organizations.
An accelerated depreciation rate is calculated at a fixed percentage of the straight-line depreciation rate in the declining balance method. The accelerated depreciation rate is applied to the remaining book value of the asset for annual depreciation expense.
Depreciation Expense = Remaining Book Value X Accelerated Depreciation Rate
The accelerated depreciation rate is the ‘specific percentage’ of the straight-line rate. In most cases, it is 200% of the straight-line rate. Hence, it is called a double-declining balance.
Let’s understand this using the same example of $18000 worth of plant with $2000 residual value and 5 years of useful life.
The straight-line rate was 20%(1 divided by 5). For the accelerated rate, we will take 200% of 20%. It will become 40% which is an exact double of 20%.
The depreciation schedule for the plant is given below.
|Year||Computation||Depreciation Expense||Accumulated Depreciation||Book Value|
|1||18000 * 40%||$7,200||$7,200||$10,800|
|3||6480 * 40%||$2,592||$14,112||$3,888|
In some cases, the 150 Percent declining method is also used. It takes 150% of the straight-line depreciation rate. For the above example, the 150% of 20% will be 30%, and the depreciation schedule will be made by the declining method.
For financial reporting purposes, the business entities must record and disclose different standards used to realize, recognize, and calculate the fixed assets.
Under the IAS 16.73, The disclosure of useful life, depreciation method, the basis for measurement of carrying amount, any reconciliations in carrying amount, impairment losses, and any expenditures to construct property, plant, and equipment is necessary.
Reviewed by Sinra