Meaning of Fixed Assets

Fixed assets are long-term investments in the operation of entity. Long-term investments in terms of accounting conventions means the asset whose useful life is more than 12 months.

These assets are illiquid in nature unlike current assets which can be easily converted into cash in the period of twelve months from accounting period.

Fixed assets provide value over number of years. Fixed assets are not bought for resale like the trading but rather it is bought to create value in the business.

They are used in the routine business activities such as office building, warehouse, computerised equipment, machineries, office equipments as well as vehicles.

Meaning of Fixed assets addition

Fixed assets addition basically refer to assets that entity acquired during current accounting period in addition to previous year fixed assets balance in balance sheet.

If 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 previous year to current years.

The movement could be as the result of fixed assets disposal, fixed assets written-off and fixed assets addition.

Entity might add new fixed assets into the operating as the result of 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 on entity’s financial situation, accounting standards required entity to present fixed assets value at the end of accounting period in gross value, fixed assets addition during the period, written off or disposal during the period.

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Entity is also advice to present the accumulated depreciation and depreciation charged during the period.

Depreciation rate and useful life of fixed assets by class are also advice to disclosed with others importance 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 the fixed assets as 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 investment in purchases of fixed assets after making due diligence of the vendors and making capital budgeting decision on purchase decision.

When there is purchase, there is outflow of cash now or later on if the purchases is 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 double entry system of bookkeeping comes into play while the fixed asset is purchased, there is 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
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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.

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

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

So, there has been guidelines issued with respect to accounting of such exchanges. There are two situations when the assets are exchange. The transaction can have 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 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 given up (Being assets exchanged)XX
XX Profit/Loss on exchangeXXXX

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 exchange of fixed assets where there is no commercial substance is as:

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