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What is fixed asset accounting? 3 Things You Need to Know

Fixed asset accounting is the process of capitalizing the purchase cost, allocating the cost over the asset's useful life through depreciation, and re

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Fixed asset accounting is the process of capitalizing the purchase cost, allocating the cost over the asset’s useful life through depreciation, and removing the fixed asset from the books after an disposal. We go through each in detail and provide examples below.

What is a fixed asset in accounting? Fixed assets are long-term assets that are expected to be used for more than one operating cycle. They generate income over various periods; therefore, their costs must be deducted against profit over several periods.

1. Accounting for the fixed asset cost

The largest part of a fixed asset’s cost is its purchase or construction price. However, costs incurred to place the asset in service must also be included in the total cost of the fixed asset. It is important to determine the total cost of the fixed asset correctly, as this amount must be capitalized and placed on the balance sheet as an asset as opposed to being deducted at current earnings. You can read our Capitalize vs Expenditure article to learn more about expenses that need to be capitalized.

Here are some examples of expenses that should be capitalized as the cost of the asset for some common types of fixed assets:

2. Accounting depreciation of fixed assets

Depreciation is a method of allocating the cost of a fixed asset over the life of the asset. Since fixed assets generate income for more than one period, it is important to deduct the cost of the asset over the same period as the life of the asset.

Common depreciation methods include the straight-line method, double-declining balance, sum-of-the-years figures and production units method.

Here is a quick illustration of depreciation. Let’s assume we have a fixed asset with a cost of $ 50,000 and a salvage value of $ 2,000. It has a useful life of five years. By applying the straight-line method, our annual depreciation expense will be as follows:

Straight-line depreciation = ($ 50,000 – $ 2,000) ÷ 5 years = $ 9,600 / year

By the end of the asset’s useful life, the book value – cost less accumulated depreciation – will be its recoverable amount of $ 2,000 ($ 50,000 – $ 48,000).

You can find additional details on calculating depreciation costs in our article on how depreciation works.

3. Accounting for a Fixed Asset Disposal

At the end of a fixed asset’s useful life, the business owners can either sell the asset or retire the asset. When we have fixed assets, we must remove the cost of the asset and the accumulated depreciation from the books. If we sell the asset for more than its book value, we recognize a profit. If we sell it for less than its book value, we acknowledge a loss.

Using the preceding example, suppose we sold the asset at a book value of $ 2,000 for $ 1,100 to a scrap dealer. Our entry to record this alienation transaction would be:

Bottom Line

Fixed asset accounting consists of recording the asset’s costs, the periodic depreciation over the asset’s useful life and the asset’s eventual disposal. You can get a much better measure of profit and loss if you set off your fixed assets properly as opposed to deducting them when purchased, which is often allowed for federal income tax purposes.

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