What it means
A business holds two broad kinds of assets: those it expects to turn into cash within a year, such as stock and receivables, and those it keeps to generate income over many years. Fixed assets belong to the second group.
They are sometimes called property, plant and equipment, or non-current assets. When a fixed asset is bought, it is recorded at its cost, which includes the purchase price plus the expense of getting it ready for use, such as delivery and installation.
It is then depreciated over its expected useful life, so that the cost is matched to the years in which the asset helps earn revenue. Land is normally not depreciated because it does not wear out.
The balance sheet shows fixed assets at net book value, which is cost less accumulated depreciation. This figure is an accounting number and may differ widely from the market value.
A fully depreciated machine may still run perfectly well, and a property may be worth far more than its recorded value. Companies set a capitalisation threshold, such as $2,500, below which items are expensed immediately rather than recorded as fixed assets.
This keeps the asset register manageable and avoids tracking low-value items. A fixed asset register records each item, its cost, location, depreciation and disposal.
Managers watch fixed assets because they tie up cash and drive depreciation and maintenance costs. Ratios such as fixed asset turnover show how much revenue the business generates for every dollar invested in them.
Asset-heavy firms, like manufacturers and airlines, need large amounts of capital, while service firms may need little. Fixed assets can lose value suddenly if they become obsolete or damaged, which leads to impairment charges.
When they are sold, any difference between sale proceeds and net book value is recorded as a gain or loss on disposal.
In practice
Real-world examples
Example 1
A bakery purchases a commercial oven for $25,000. The oven will be used for ten years, so the cost is spread over that time as depreciation instead of being expensed in the first year. The depreciation charge of $2,500 a year appears in the income statement each period.
Example 2
A consulting firm buys laptops costing $1,200 each, which falls below its $2,500 threshold. The laptops are expensed immediately and do not appear in the fixed asset register. Setting a sensible threshold saves the team hours of tracking items that have little financial effect.
Example 3
A logistics company owns a warehouse bought for $3,000,000 several years ago. It shows the building on the balance sheet at net book value, even though a recent valuation suggests it is worth much more. An insurer or lender may ask for a current valuation, which would be separate from the accounting records.
Think of it
Fixed assets are like the big tools in a mechanic's shop-the lifts, diagnostic machines, and compressors that stay put and are used year after year.
Formula
Calculation
Annual straight-line depreciation = (Cost - Residual value) / Useful life in years
Net book value = Cost - Accumulated depreciation
Bayside Packaging, a fictional company, buys a machine for $90,000 with an expected residual value of $10,000 and a life of 8 years. Annual depreciation is ($90,000 - $10,000) / 8 = $80,000 / 8 = $10,000. After 3 years, accumulated depreciation is 3 x $10,000 = $30,000, so net book value is $90,000 - $30,000 = $60,000. If the company sells the machine then for $65,000, it records a gain of $65,000 - $60,000 = $5,000.Case study
Seen in the real world
Ridgeway Printing is an illustrative, fictional business that had never kept a proper asset register. During an audit, the accountants found several presses that had been sold years earlier but were still sitting on the books.
The write-off of those missing assets reduced the balance sheet by $420,000 and caused a one-time charge to profit. The audit also found that two presses in daily use had been fully depreciated and were not being tracked for maintenance.
In the illustrative clean-up, Ridgeway introduced a full register with asset tags, annual physical checks and a clear capitalisation policy. Insurance cover was updated to match the real equipment, and the finance team could finally explain the depreciation charge to the lender. The finance director now reviews the register at every year end, comparing it with a physical count and with the insurance schedule.
Watch out
Common mistakes
- Treating net book value as the market value of an asset, when it is only an accounting figure.
- Depreciating land, which is not normally depreciated because it has an unlimited life.
- Leaving disposed assets on the register, which overstates assets and depreciation.
Questions
People also ask
What is the difference between fixed assets and current assets?
Fixed assets are held for long-term use over several years, while current assets are expected to be converted into cash within a year.
How are fixed assets recorded?
They are recorded at cost and then depreciated over their useful life, with the unallocated cost shown as net book value.
What is an impairment?
It is a write-down of an asset when its recoverable value falls below its book value.
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