Fixed Asset Process
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This document provides a comprehensive overview of fixed assets, including their definition, procurement, accounting entries, depreciation methods, and disposal processes. Key concepts covered include the asset life cycle, various depreciation techniques, and the financial impact of asset disposal. Additionally, it emphasizes the importance of adhering to accounting principles and the implications of depreciation on financial statements.
Fixed Asset Process
- 1. 1 CMA Satish Narayan B.com, MBA(Finance), ACMA, (M.com) Listen to everyone; but select the right one - Satish Narayan [email protected] @Satishn06 https://www.quora.com/profile/Satish-Narayan-13 Get in touch with me
- 2. Fixed Asset Procurement > Capitalization > Disposal 2 Disclaimer : All materials provided by me here is for information purposes only. Although every reasonable effort is made to present current and accurate information, I would make no guarantees of any kind and cannot be held liable for any outdated or incorrect information. E&OE.
- 3. Objectives At the end of this lesson, you should be able to know the : • Basics & Meaning of Fixed Assets • Procurement Cycle • Asset Life Cycle • Accounting Entries of Fixed Assets • Depreciation of Fixed Assets • Depreciation Methods • Asset Disposal
- 4. Basics & Meaning of Fixed Assets A Fixed Asset is an item with a useful-life of greater than one reporting/financial/fiscal period, and which exceeds an entity's minimum capitalization threshold limit. A Fixed Asset is not purchased with the intent of immediate resale, but rather for productive use within the entity. An inventory item CANNOT be considered as a fixed asset, since it is purchased with the intent of either reselling it directly or incorporating it into a product that is then sold. Some of the examples are : Land & Building, Building Structures, Furniture & Fixtures, Computer Equipment, Software, Vehicles, Aero Plane, Intangible Assets, Leasehold Improvements, Plan & Machinery etc., 4
- 5. Basics & Meaning of Fixed Assets Fixed Assets are recorded in the books with below Accounting Transactions : ▼ Periodic Depreciation or Amortization for Tangible & Intangible assets respectively ▼ Impairment write-downs (when the value of an Asset declines below its net book value) ▼ Disposition(once assets are disposed off) A Fixed Asset appears in the financial records at its Net Book Value(NBV), which is its Original Cost, minus Accumulated depreciation, minus any impairment charges. Because of ongoing depreciation, the NBV of an asset is always declining. A Fixed Asset does not actually have to be “Fixed," in that it cannot be moved. Many Fixed Assets are portable enough to be routinely shifted within a company's premises, or entirely off the premises. Thus, a laptop, computer could be considered as a Fixed Asset (as long as its cost exceeds the capitalization limit). A fixed asset is also known as Property, Plant, and Equipment(PP&E). 5 Source : AccountingTools
- 6. Invoices will be generated and goods are ready for shipment Vendors delivers the goods to the Ship-to address Is PO meeting the threshold? Consider as Operating Expenditure Invoices will hit to Purchase Account and Fixed Asset team to Capitalize PR flows to series of approvers and Purchase Order(PO) will be generatedSTART • Apply GAAP Criteria – viz., Criteria for Value, Life etc., NO ENDTagging of asset Validation as per GAAP Invoicing stage Procurement Cycle Purchase Requisition Stage The Purchase Request (PR) is initially placed Validate the PO against PR/Invoice and ensure accurate tax is paid Capitalize as per GAAP YES Details to validate Note : Payment aspects not discussed here
- 7. 7 Assets Life Cycle Image : ManageEngine & Maintenance Asset Owner
- 8. 8 Assets Life Cycle Procurement : o Create Purchase Request o Approval of PR by various businesses o Link the PR to the Cost Centres for budgets o PO final approvals o Post-purchase, adding to the assets inventory Deploy and Discover o Deploy the assets and change state from inventory to in-use o Discover the assets in the network for software and hardware inventory o Allocate software to a hardware asset o Asset tagging Maintain o Schedule scans and get audit history o Complete ownership tracking o Software compliance and license management o Asset depreciation calculations o Total cost of ownership of an asset Support o Maintain contracts for assets o Notify technicians of expiry dates o Software license agreements are linked to the software Retirement and Disposal o Change the state of an asset to expired/disposed o All the software allocated to the disposed asset will get un-allocated Source : ManageEngine
- 9. Accounting Entries of Fixed Assets Example : You purchase a vehicle for your business for $35,000. Vehicles are usually considered five-year property. Assuming you use the straight-line method to depreciate the asset, you would record $7,000 depreciation expense per year on your income statement Entries as follows : Using the example above, this is what the journal entry to record the capitalized asset would look like: Vehicle Account (asset account) $35,000 (debit) Cash/Bank Account (asset account) $35,000 (credit) If you made a $5,000 deposit and financed the rest through your bank, the journal entry to capitalize the asset, would be: Vehicle (asset account) $35,000 (debit) Cash (asset account) $5,000 (credit) Notes Payable (liability account) $30,000 (credit) 9
- 10. Accounting Entries(continued) Using the example of the $35,000 vehicle purchases, this is what a basic journal entry would look like: Depreciation Expense $7,000 (debit) Accumulated Depreciation $7,000 (credit) 10 Note : All of the above sample journal entries would only affect and show on your balance sheet. As stated above, the total cost of capitalized assets (except for land) will be expensed or depreciated out over the useful life of the asset. We do this through an income statement expense account titled “Depreciation Expense” and a contra account in the asset section of your balance sheet titled “Accumulated Deprecation“. Contra?-A contra account is an account that offsets a corresponding account. So an accumulated depreciation contra account offsets or reduces your fixed assets accounts. Source :basicaccountinghelp
- 11. Depreciation of Fixed Assets In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in a systematic manner until the value of the asset becomes zero or negligible. Depreciation allows a portion of the cost of a fixed asset to the revenue generated by the fixed asset. This is mandatory under the matching principle as revenues are recorded with their associated expenses in the accounting period when the asset is in use. This helps in getting a complete picture of the revenue generation transaction. As we already know the purpose of depreciation is to match the cost of the fixed asset over its productive life to the revenues the business earns from the asset. It is very difficult to directly link the cost of the asset to revenues, hence, the cost is usually assigned to the number of years the asset is productive. Over the useful life of the fixed asset, the cost is moved from balance sheet to income statement. Alternatively, it is just an allocation process as per matching principle instead of a technique which determines the fair market value of the fixed asset. 11
- 12. Depreciation Methods Straight-line : The simplest and most commonly used method, straight-line depreciation is calculated by taking the Purchase or acquisition price of an asset, subtracting the salvage value (value at which it can be sold once the company no longer needs it) and dividing by the total productive years for which the asset can reasonably be expected to benefit the company (or its useful life). Unit-of-Production : This method provides for depreciation by means of a fixed rate per unit of production. Under this method, one must first determine the cost per one production unit and then multiply that cost per unit with the total number of units the company produced within an accounting period to determine its depreciation expense. Depreciation Expense = Total Acquisition Cost - Salvage Value / Estimated Total Units Estimated total units = the total units this machine can produce over its lifetime Depreciation expense = depreciation per unit * number of units produced during an accounting period Hours-of-Service : This is the same concept as unit of production depreciation except that the depreciation expense is a function of total hours of service used during an accounting period. 12
- 13. Depreciation Methods Accelerated Depreciation : Accelerated depreciation allows companies to write off their assets faster in earlier years than the straight-line depreciation method and to write off a smaller amount in the later years. The major benefit of using this method is the tax shield it provides. Companies with a large tax burden might like to use the accelerated-depreciation method, even if it reduces the income shown on the financial statement. This depreciation method is popular for writing off equipment that might be replaced before the end of its useful life if it becomes obsolete ( computers, for example). Companies that have used accelerated depreciation will declare fewer earnings in the beginning years and will seem more profitable in the later years. Companies that will be raising financing (via an IPO or venture capital) are more likely to use accelerated depreciation in the first years of operation and raise financing in the later years to create the illusion of increased profitability (and therefore higher valuation). The two most common accelerated-depreciation methods are the a. Sum-of-year (SYD) method and b. Double-declining-balance method (DDB) 13 Source : Investopedia
- 14. Depreciation Methods Other methods are : Diminishing Value Method Annuity method Revaluation method Insurance Policy 14 Source : accountingnotes Note : There are many other types of depreciation. However for basic understanding purpose, only few types are discussed here
- 15. Asset Disposal Disposal of fixed assets is accounted for by removing the cost of the asset and the related accumulated depreciation from balance sheet, recording receipt or cash proceeds and recognizing any resulting gain or loss. A company may need to derecognize a fixed asset either upon the sale of the asset to another party or when the asset is no longer operational and is disposed off. Whether a de-recognition results in a gain or loss or no gain and loss depends on whether the cash proceeds (if any) from the sale are higher than the carrying amount of the asset at the time of disposal or not. 15 M/s. S & Co., purchased a software for $100,000 on 1st April 2010. The software license was valid for four years. At the time of expiry, i.e. 31st March 2014, Company shall record the derecognition/disposal as follows: Accumulated amortization-software 100,000 (dr) Cost-software 100,000 (cr)
- 16. Asset Disposal Example 1 – With Gain : On 1st April 2010, DD & Co., has purchased equipment at a cost of $2 million. The company estimated its salvage value to be $0.2 million at the end of useful life of 5 years. The company depreciated the asset on a straight-line basis i.e. $360,000 per year ((2,000,000 − 200,000) ÷ 5) resulting in the carrying amount as at 31st March 2015 of $0.2 million. Actual proceeds from sale of the used asset turned out to be $0.5 million. Since the sale proceeds exceed the carrying amount by $0.3 million ($0.5 million − $0.2 million) so a gain is to be recognized using the following journal entry: 16 Accumulated depreciation-equipment 1,800,000 (dr) Cash 500,000 (dr) Cost-equipment 2,000,000 (cr) Gain of disposal 300,000 (cr) The equipment cost and the related accumulated depreciation are removed from balance sheet in the process of disposal and the gain is reported in income statement.
- 17. Asset Disposal Example 2 With Loss : M/s. R & Co., purchased a specialized trading terminal for $4 million on 1 January 2006. The company expected the system to last 5 years and generate a residual value of $0.5 million. However, due to rapid changes in technology, the company was forced to abandon the system only after 2 years for $1.5 million and invest in new infrastructure. In the two years, the depreciation expense charged i.e. the accumulated depreciation on the terminal = ($4 million – $0.5 million) ÷ 5 × 2 = $1.4 million Carrying amount at the time of disposal = $4 million – $1.4 million = $2.6 million Since the cash proceeds ($1.5 million) is less than the carrying amount (i.e. $2.6 million), the disposal has resulted in a loss of $1.1 million ($2.6 million - $1.5 million). 17 Accumulated Depreciation-terminal 1,400,000 (dr) Cash 1,500,000 (dr) Loss of Disposal 1,100,000 (dr) Cost-terminal 4,000,000 (cr) The accounting transaction results in removal of the trading terminal from balance sheet and recognition of the loss in income statement. Net effect on total assets is a decrease of $1.1 million (-$4,000,000 + $1,400,000 + $1,500,000) which is also reflected by equivalent decrease in shareholders’ equity.
- 18. Asset Disposal Example 3 With No-Gain No-Loss : Company D sold an asset to Company Z for $ 2 million. Company Z depreciated the asset on straight-line basis for 4 years. Company D offered to buy-back the asset at $0.4 million at the end of useful life of the asset. Hence, Company Z estimated salvage value to be $0.5 million Accumulated depreciation at the end of 4 years = ($2 million – $0.4 million) ÷ 4 × 4 = $1.6 million Carrying amount at the end of 4 years = $4 million - $1.6 million = $0.4 million 18 Accumulated depreciation 1,600,000 (dr) Cash 400,000 (dr) Cost 2,000,000 (cr) If the carrying amount of a fixed asset at the date of disposal is equal to the sale proceeds from disposal, there is neither gain nor loss. Source : Accountingexplained
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