Fixed Asset Accounting and Depreciation Methods

Fixed assets are long-term tangible assets used in business operations to generate revenue over multiple periods.

Companies must properly account for acquisition, depreciation, impairment, and disposal of fixed assets to comply with financial reporting standards.

Depreciation methods systematically allocate the cost of assets over their useful lives, impacting profit measurement and tax calculations.

Incorrect depreciation calculations or asset misclassification can result in material misstatements of financial statements.

Overview / Definition

Fixed assets, also known as property, plant, and equipment (PP&E), include tangible assets such as land, buildings, machinery, vehicles, and furniture.

These assets are not intended for immediate sale but are used to support the company’s operations and generate long-term economic benefits.

Fixed assets are initially recorded at historical cost, which includes purchase price and directly attributable costs to bring the asset to its intended use.

Over time, assets (excluding land) are subject to depreciation to reflect wear and tear or obsolescence.

Recognition and Measurement

Initial Recognition:

✦ Historical cost includes the purchase price, non-refundable taxes, installation, testing, and delivery costs.

✦ Subsequent costs that enhance productivity or extend useful life are capitalized; routine maintenance is expensed.

Depreciation Methods:

✦ Straight-Line Method: Allocates an equal amount of depreciation each year.

✦ Declining Balance Method: Applies a constant depreciation rate to the asset’s remaining book value.

✦ Units of Production Method: Depreciation is based on usage or output levels.

✦ Sum-of-the-Years'-Digits Method: Accelerates depreciation in the early years of asset life.

Example – Straight-Line Depreciation:

An asset costs $50,000, has a useful life of 5 years, and a residual value of $5,000.

Annual Depreciation = ($50,000 – $5,000) ÷ 5 = $9,000 per year.

Initial Journal Entry (Asset Purchase):

debit Fixed Assets – Machinery – 50,000

credit Cash – 50,000

Annual Depreciation Entry:

debit Depreciation Expense – 9,000

credit Accumulated Depreciation – Machinery – 9,000

Journal Entry Examples

1. Asset Purchase with Additional Installation Costs:

debit Fixed Assets – Equipment – 80,000

credit Cash – 80,000

2. Annual Depreciation – Declining Balance Method (Assuming 20% Rate):

debit Depreciation Expense – 16,000

credit Accumulated Depreciation – Equipment – 16,000

3. Asset Disposal (Fully Depreciated Asset):

debit Accumulated Depreciation – Equipment – 80,000

credit Fixed Assets – Equipment – 80,000

4. Asset Disposal with Gain (Sale Price $10,000, Net Book Value $8,000):

debit Cash – 10,000

debit Accumulated Depreciation – Equipment – 72,000

credit Fixed Assets – Equipment – 80,000

credit Gain on Disposal – 2,000

Disclosure Requirements

Companies must disclose their accounting policies for fixed assets and depreciation in the financial statement notes.

Key disclosure items include:

✦ Classes of fixed assets and their carrying amounts.

✦ Depreciation methods used and useful life assumptions.

✦ Accumulated depreciation and impairment losses recognized.

✦ Reconciliation of beginning and ending balances of fixed assets.

✦ Information on significant asset disposals or impairments during the period.

IFRS Comparison

Criteria	US GAAP (ASC 360)	IFRS (IAS 16)
Measurement after Recognition	Historical Cost	Cost or Revaluation Model
Depreciation Methods	Various Accepted	Various Accepted
Component Depreciation	Not Mandatory	Required if Significant
Impairment Review	Trigger-Based	Annual Assessment
Residual Value Review	No Specific Frequency	Annually

IFRS allows the revaluation model, where assets can be carried at fair value, while US GAAP typically uses historical cost.

Common Errors

✦ Incorrect Useful Life Estimates: Using unrealistic useful life estimates affects depreciation expense and net income.

✦ Omitting Component Depreciation: Not separating significant parts of assets for individual depreciation calculations under IFRS.

✦ Improper Capitalization of Costs: Capitalizing routine maintenance instead of expensing it immediately.

✦ Failing to Record Impairments: Not recognizing permanent reductions in asset value, leading to overstated asset balances.

✦ Incorrect Disposal Accounting: Failing to remove both the asset’s cost and accumulated depreciation when disposing of fixed assets.