What it means
Accountants call these tangible assets and split them into two families. Fixed or non-current assets are items the business keeps and uses for more than a year, such as a delivery van or a warehouse, while current assets include inventory and anything else expected to turn into cash within the year.
The distinction drives where the item appears on the balance sheet and how its cost reaches the profit and loss account. The contrast is with intangible assets such as brands, software licences, patents, customer lists and goodwill.
Intangibles have become a far larger share of the value of modern businesses, which is why a software company can be worth a great deal while owning almost nothing physical. Physical assets still dominate in manufacturing, property, logistics, hospitality and agriculture.
Physical assets are recorded at cost, which includes the purchase price plus anything spent getting the asset ready for use, such as delivery, installation and testing. That cost is then spread across the asset's useful life through depreciation, so each year carries a slice of the expense rather than year one carrying all of it.
What remains on the balance sheet is the carrying value, often called net book value. Because they can be seen, counted and sold, physical assets appeal to lenders.
Asset finance, hire purchase and secured loans all rely on the lender being able to repossess the item, which usually makes the borrowing cheaper than an unsecured facility. The flip side is that physical assets absorb cash, require maintenance and insurance, and can become obsolete long before they are fully depreciated.
Carrying value is an accounting number, not a market price. A five-year-old fleet may be nearly written down to zero in the books while still fetching real money at auction, and a highly specialised machine may be worth far less than its carrying value because almost nobody else can use it.
Whenever the recoverable amount drops below the carrying value, the asset should be written down through an impairment charge.
In practice
Real-world examples.
Example
A coffee roaster buys a $180,000 roasting drum and depreciates it over ten years at $18,000 a year. Because the machine holds its resale value well, the owner knows the fifth-year carrying value of $90,000 understates what the drum would actually fetch.
Example
A dental practice finances four treatment chairs on hire purchase. The chairs appear as physical assets on the balance sheet with a matching liability, so the practice shows both the asset it controls and the debt it owes rather than treating the payments purely as an expense.
Example
A haulage firm sends twelve fully depreciated trailers to auction and raises $96,000. Since the trailers carried a book value of zero, the entire amount is recorded as a gain on disposal, which flatters that month's profit without reflecting any change in trading performance.
Formula
Calculation
Straight-line depreciation = (Cost - Residual Value) / Useful Life
Carrying value = Cost - Accumulated Depreciation
Suppose a packaging business buys a labelling machine for $240,000 including delivery and installation. Management expects to use it for eight years and then sell it for around $40,000.
Annual depreciation = ($240,000 - $40,000) / 8 = $200,000 / 8 = $25,000 a year.
After three years, accumulated depreciation is 3 x $25,000 = $75,000, so the carrying value is $240,000 - $75,000 = $165,000.
If a buyer offers $150,000 at that point, selling produces a loss on disposal of $165,000 - $150,000 = $15,000, because the proceeds fall below the carrying value. That loss is an accounting entry correcting an earlier depreciation estimate, not a fresh cash cost.Case study
Seen in the real world.
Calder Valley Foods is an illustrative chilled food producer used to show why carrying value and real value drift apart. The company's balance sheet showed $2,400,000 of plant and equipment at carrying value, and the board treated that figure as a rough guide to what the assets were worth.
When a potential buyer commissioned an independent valuation, the picture split in two. The refrigeration units and standard packing lines, carried at $1,500,000, were valued at roughly $1,700,000 because equipment prices had risen and the units were well maintained. The bespoke portioning line, carried at $900,000, was valued at $250,000, because it had been built for one discontinued product and only two other producers in the country could use it.
In this fictional case the company recorded an impairment on the specialised line and adjusted its depreciation policy so that bespoke equipment was written off over four years instead of ten. The lesson the illustrative board took away was that useful life should reflect how long the asset will be needed for its purpose, not how long it will physically keep running.
Watch out
Common mistakes.
- Treating carrying value as market value, when the book figure is simply cost less accumulated depreciation and can sit well above or well below what a buyer would pay.
- Expensing the full cost of a large asset in the year of purchase instead of capitalising it, which distorts profit in that year and every year afterwards.
- Leaving assets that have been scrapped, sold or written off sitting in the fixed asset register, which inflates both the balance sheet and the depreciation charge.
Questions
People also ask.
What is the difference between a physical asset and a fixed asset?
Physical simply means tangible, while fixed means held for long-term use, so inventory is a physical asset but not a fixed one.
Do physical assets always have to be depreciated?
Almost always, with land being the main exception because it is not considered to have a limited useful life, though buildings on that land are still depreciated.
How does owning physical assets affect borrowing?
It generally helps, because a lender can take security over a specific item and recover value if the loan fails, which usually means a lower interest rate than unsecured borrowing.
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