Insights

What are Fixed Assets?

October 4, 2024

As the term might suggest, fixed assets are assets that are “fixed” or stay with a company for longer than one year. These assets can be a wide range of items including land, buildings, machinery, vehicles, and computers. Besides tangible items, fixed assets can also be intangible such as franchise purchases, patents, and trademarks.

Fixed assets are not just limited to purchases of new equipment or vehicles. If a large repair was made to a piece of equipment that extends its life, then that could be considered an asset. Similarly, if significant modifications are made to rental property, the expenses can be capitalized as leasehold improvements.

A business should consider having a capitalization policy created. Capitalization is the process of determining if a purchase should be recorded as a fixed asset or expense. A capitalization policy details the criteria the business has for reviewing purchases and deciding whether they are fixed assets or expenses. A capitalization policy typically includes a dollar threshold to assist with the decision-making process.

Depreciation & Amortization

Fixed assets have a set life, and, over the course of their life, their value depreciates or decreases. Intangible fixed assets lose value in a similar way, but it is called amortization. The life and rate that a fixed asset depreciates depends on many things such as the depreciation method, type of asset, and when the asset was acquired.

How does depreciation affect a company’s finances?

When it comes to accounting, depreciation plays an important role. When a company records fixed assets, and, therefore depreciation, two additional accounts are required. These accounts are Accumulated Depreciation and Depreciation Expense, and each affects the company’s financials in different ways.

The Accumulated Depreciation account is a contra asset account which decreases the total asset value. The Depreciation Expense account is just as it seems, an expense account. When recording depreciation, Accumulated Depreciation is credited, and Depreciation Expense is debited.

Besides affecting expenses and assets, depreciation also plays a role when a fixed asset is sold. When an asset is fully depreciated, the book value is zero. According to the company’s financials, the asset has no value because the tax life of the asset has been fulfilled. When a fully depreciated fixed asset is sold, any money received will be considered a gain and income for the business. If a partially depreciated asset is sold, it won’t be a 100% gain because there is still value in the asset. If the sale price is higher than the remaining book value, a gain will be recognized. If the price is lower than the remaining book value, the business records a loss on the sale.

How do fixed assets affect a company’s taxes?

Besides finances, fixed assets and depreciation can also affect a business’s taxes. With depreciation reducing assets and profit, taxable income is also reduced. This, of course, means that a company has lower income subject to taxes.

Companies can also apply accelerated depreciation such as bonus depreciation and Section 179. Bonus depreciation allows companies to depreciate most, if not all, of the value of an asset almost immediately to have as low taxable income as possible. Instead of deducting depreciation over several years, the percentage of depreciation is recorded in the first year. It should also be noted that the percentage that can be depreciated in this method can change from year to year.

Section 179 is a tax deduction created by the IRS as an incentive for businesses to buy new equipment. This can be beneficial to new businesses who need to purchase a lot of equipment to start their business. Section 179 depreciation has thresholds set by the IRS but offers flexibility by allowing a business to choose the amount of the deduction within the threshold.

There are many variables to consider with fixed assets and depreciation. A tax advisor or accountant can help a business create a capitalization policy, review their expenses and assets, record sales of assets, and determine how the assets should be depreciated. For specific questions, assistance, or additional information, please do not hesitate to contact a member of our Entrepreneurial Accounting Solutions team.

This article was written by EAS intern Emily Zeger under supervision of Senior Accountant Becky Lauffer during McKonly & Asbury’s 2024 Fall Internship Program.