Fixed Assets can be defined as the resources that the company possesses for the long term, that cannot be immediately converted to cash. Examples of fixed assets include property, plant, equipment, as well as other intangible assets that the company might possess.
Fixed Assets are one of the most critical elements presented in the Balance Sheet of the company. This is because it is directly indicative of the financial standing, and overall financial health of the company. Therefore, fixed asset management holds tantamount importance from the perspective of the company, so that financial planning can be executed in a smoother manner.
Fixed Asset Addition
Fixed Asset additions refer to the purchase of fixed assets during a given period. Whenever an organization purchases fixed assets during an accounting period, it is mentioned in the balance sheet of the company.
Accounting for Fixed Asset Additions
There are two main methods that are used by companies when adding fixed assets. These methods are as follows:
- Fixed Asset Acquisition
- Self-Constructed Fixed Assets
Fixed Asset Acquisition:
Fixed Asset acquisition is the most common method that is used to obtain assets. It is mostly acquired from external sources of the business, and therefore, it is referred to as ‘acquisition’ in the literal sense. Fixed Assets are said to be acquired by the company when the risks and the rewards of the underlying asset are transferred from the supplier to the purchaser. Fixed assets are included and subsequently disclosed in the balance sheet even if they are not brought to use as yet. This implies that companies are supposed to include all the fixed asset purchases, regardless of the extent to which they have been used.
The journal entry to record the acquisition of fixed assets is as follows:
It must also be noted that in addition to the purchase price of the fixed asset, there are several different cost components that need to be included in the cost of the asset itself. The following cost components need to be included in order to record Fixed Assets properly:
- Underlying cost of the asset
- Custom and Import Duty
- Installation Fee
- Professional Fee associated with Fixed Asset set up
- Materials required to bring Fixed Assets into the usable state
Self-Constructed Fixed Asset
As far as self-constructed fixed assets are concerned, it can be seen that it is defined as an asset that the company builds from within. The most common examples of fixed assets include buildings, as well as some other infrastructures. The construction that a company uses to subcontract to other companies is not categorized as a self-constructed fixed asset.
In the same manner, it can be seen that all the costs that are associated with work in progress are also associated with the construction process. Subsequently, after all the work has been completed, these costs are then added back to the costs, when there is no work-in-progress remaining.
|Work in Progress||xxx|
For self-constructed assets, the following costs need to be included:
- Material: All the material that is utilized in the production process, including steel, concrete, as well as other associated costs are supposed to be included under the cost of fixed assets.
- Labor: This refers to the human capital that is paid for purposes of construction.
- Production overheads: All costs associated with rentals, salaries of managerial staff, as well as other departments are also included to ensure that they work partially on the said project.
- Interest Expenses: Interest expenses that might be occurred during the construction phase is also used in the construction process.
- Depreciation Expenses: Depreciation expenses that are incurred on tools, and other related equipment is also included in capitalization of the fixed assets.
Fixed Asset Exchange
Exchange of Fixed Asset can be referred to as the transaction that is incurred as a result of the exchange of a given fixed asset owned by the company, with another fixed asset. In fixed asset exchanges, one fixed asset is disposed of, and a new one is procured as a replacement of the old asset. However, for an exchange to hold, and be categorized as such, it is important for companies to ensure that the transaction is of commercial substance. Commercial substance implies that the transaction or the exchange of fixed assets is likely to impact the future cash flows of the business.
Accounting for Fixed Asset Exchange
The exchange of fixed assets might either result in a gain or loss. However, the journal entries for gains and losses are different.
As far as the loss is concerned, the company records the new asset received at the market value and removes the asset at the carrying value from the Balance Sheet. On the other hand, in the case of gain on the exchange of fixed assets, the gain is not represented on the income statement. The company records the new assets at the market value of the asset less the gain on the exchange.
Journal Entries to record loss on the exchange of Fixed Assets
|Loss on Exchange of Fixed Asset||xxx|
|Accumulated Depreciation (old)||xxx|
|Fixed Asset (old)||xxx|
Journal Entries to record a gain on the exchange of Fixed Assets
|Fixed Asset (new)||xxx|
|Accumulated Depreciation (old)||xxx|
|Fixed Asset (old)||xxx|
Example of Fixed Asset Exchange
Kylie Co. is a textile manufacturer, which currently has a stitching unit with a capacity of 100 suits per hour. However, they now require a larger stitching unit with a capacity of 250 suits per hour. In order to accommodate for the increase in capacity, they plan on exchanging the existing machine with the new machinery. They contacted the manufacturer, and they mutually decided to exchange the smaller stitching with the new stitching unit.
The situation above describes a prime example of fixed asset exchange between the companies. Kylie Co. exchanged the older machinery with the new machinery, and hence, they managed to make the transaction in place.
Differences between Fixed Asset addition, and Fixed Asset exchange
Fixed Asset addition and fixed asset exchange are two different ways in which assets are added to the balance sheet of the company. There are some fundamental differences between both these concepts. The differences between fixed asset addition and exchange are as follows:
- Fixed Asset addition does not comprise of any fixed asset swaps. It is merely purchasing one asset from a third-party vendor (or constructing it in case of self-constructed assets), without removing any existing assets. However, the company might choose to dispose of the asset and then purchase a new one from another vendor. That is also regarded as a Fixed Asset addition.
- Fixed Asset exchange requires changing one asset in place of another, with same party that is involved. In other words, the asset exchange takes place between the same parties only.
- Fixed asset addition, and fixed asset exchange both require fixed asset movements. However, with fixed asset addition, a single asset is added to the balance sheet of the company. Fixed asset exchange normally does not change the asset standing, since one machinery is merely exchanged with another machinery.