Meaning:

Fixed assets are long-term investments in the operation of an entity. Long-term investments in terms of accounting conventions mean the asset whose useful life is more than 12 months. These assets are illiquid in nature, unlike current assets that can be easily converted into cash in twelve months from the accounting period.

Fixed assets provide value over several years. Fixed assets are not bought for resale like trading, but rather it is bought to create value in the business. They are used in routine business activities such as office building, warehouse, computerized equipment, machinery, office equipment, and vehicles.

Meaning of Fixed Assets Addition

Fixed assets addition basically refers to assets that the entity acquired during the current accounting period in addition to the previous year’s fixed assets balance in the balance sheet.

Suppose you look into the note to financial statements for fixed assets in your annual audit report or annual financial statements. You will see the note present the movement of fixed assets in gross value from the previous year to the current year.

The movement could result from fixed assets disposal, fixed assets written-off, and fixed assets addition.

An entity might add new fixed assets into the operating due to operational expansion, replace the old assets after written off or disposal or introduce the new version of assets for operational efficiency.

To improve users’ understanding of the entity’s financial situation, accounting standards required the entity to present fixed assets value at the end of the accounting period in gross value, fixed assets added during the period, written off or disposal during the period.

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The entity is also advised to present the accumulated depreciation and depreciation charged during the period.

Depreciation rate and useful life of fixed assets by class are also advised to be disclosed with other important accounting policies. Fixed assets addition are also fixed assets; therefore, the recognition and measurement are followed the same accounting principle.

There are two methods to add fixed assets: direct acquisition of fixed assets and exchange of one fixed asset with another.

Accounting for Fixed Assets Addition

As we discussed two methods of fixed assets addition, now, we will talk about accounting treatment for fixed assets in these two cases as:

  • Direct Procurement from vendors

In plain language, this means making fresh investments in fixed-assets purchases after making due diligence of the vendors and making capital budgeting decisions on the purchase decisions.

There is a cash outflow when there is purchase now or later on if the purchases are made through credit.

For instance: Apple Inc purchases machinery A for packing its inventory and automate the process. The cost of purchase is $ 40,000.

Here, the principle of the double-entry system of bookkeeping comes into play while the fixed asset is purchased. There is an outflow of cash in case of payment, or liability is created when the purchase is made on credit. Assuming the purchase has been made by cash payment, the journal entry would be as:

DescriptionDebit Credit
Fixed Assets            $ 40,000
To cash
(Being assets purchased for cash)
$ 40,000
  • Fixed assets added in exchange

In this scenario, new fixed assets are added to the list of existing fixed assets in exchange for fixed assets which is not needed now. This can be due to reason of simple exchange.

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This may also be due to strategic acquisition. For example, the company wants to foray into the manufacture of sweet candy and stop the production of lollipops as it has been a non-performer for years.

Such exchange of assets is difficult to record and recognize the amount in the books of accounts.

So, there have been guidelines issued concerning the accounting of such exchanges. There are two situations when the assets are exchanged. The transaction can have a commercial substance or not. This is discussed below:

Exchange involving commercial substance:

When the business exchanges fixed assets with another and transaction has commercial substance, the business records the asset acquired at its fair value or fair value of assets given up, whichever is more readily available.

In such a case, the journal entry is the new asset is debited alongside accumulated depreciation, and the old asset is credit. The difference is due to profit/loss on exchange.

DateDescriptionDrCr
XXNew Fixed Assets
Accumulated Depreciation
XX  
XXOld Fixed assets were given up (Being assets exchanged) XX
XX Profit/Loss on exchange   XXXX

Exchange involving no commercial substance:

When no commercial substance exists, the asset swap has no accounting impact as there is no significant change. However, this may result in profit and loss.

Further, if cash is paid in part, it shall be credit. A sample journal entry in a case of an exchange of fixed assets where there is no commercial substance is as:

DateDescriptionDrCr
XXNew Fixed Assets
Accumulated Depreciation
XX
XXTo Old, Fixed assets were given up           
To cash
(Being assets exchanged)
    XX
XX Profit/Loss on exchange            XXXX