Fixed assets are long-term, tangible assets used for more than a year to produce goods and/or services. Also referred to as Property, Plant, or Equipment, fixed assets are valuable to a business for more than one accounting period and depreciate over the life of the asset.
Understanding assets is crucial to reading a balance sheet and assessing a company’s financial health. If you’re looking to grow your company, assess previous performance, or simply understand how your business works, becoming familiar with fixed assets is an important piece of the puzzle.
Definition and Examples of Fixed Assets
Compared with current assets, which are things that a business expects to convert to cash within a year, fixed assets are long-term or non-current assets, because they are not actively for sale. Fixed assets are the items owned by a company that make it possible to operate the business, such as tools, equipment, and furniture.
Both fixed and current assets together make up the left-hand side of the foundational accounting equation that makes up a balance sheet:
Assets = Liabilities + Equity
Fixed assets are usually tangible assets, and they generally fall under the Property, Plant, or Equipment (PPE) categories on a balance sheet. With the exception of land, fixed assets are depreciated over the length of their useful lives.
- Alternate name: Property, Plant, or Equipment; Non-Current Assets; Tangible Assets
- Acronym: PPE
In a restaurant, for example, there are many fixed assets necessary to run an effective business. An establishment may need tables, chairs, a bar, refrigerators, ovens, dishwashers, and working heating, ventilation, and air conditioning (HVAC) systems, along with many other physical items that allow it to make food and serve customers.
These are fixed assets because they are intended to help the business make food in order to earn income. Presumably, the business will own and use those items for many years, so they are listed as fixed assets on the balance sheet.
How Fixed Assets Work
As far as accounting concepts go, fixed assets are relatively simple. Farmers need tractors, landscapers need trucks, and as discussed above, restaurants need ovens. Most businesses, regardless of size, require some amount of Property, Plant, and Equipment to operate.
Where it becomes slightly more complicated, however, is when it comes to recording the value of the fixed asset on the balance sheet and when accounting for depreciation over the course of its life.
There are some loan products and lines of credit that allow you to borrow against fixed assets as collateral. These can be helpful for smaller businesses whose cash flow might not be enough to support a traditional loan approval.
A business can choose to capitalize a purchase of Property, Plant, and Equipment by recording the items as fixed assets and deducting a portion of their price over the length of their life. Capitalizing means that the item is recorded as a long-term asset, rather than an expense. According to generally accepted accounting principles, known as GAAP, in order for an item to be capitalized, it must be owned by the business and have a useful life of more than one year.
In the case of the restaurant owner, once they’ve chosen the oven they’d like to use in their business, rather than marking it as an expense, they would capitalize it by recording it as a fixed asset. They would record the oven’s cost, which includes the purchase price along with any cost associated with moving or installing the oven. Then, once the item is installed and in service, the restaurant owner can begin to record depreciation.
Depreciation accounts for the normal wear and tear that an item undergoes during the ordinary course of business, and it is spread out over the course of an item’s life. Depreciation begins one month after a fixed asset is placed into service and continues until an item is fully depreciated or disposed of either through salvage or sale. Depreciation is deducted from gross profit on the income statement, thereby reducing gross taxable income for the business.
There are multiple ways to calculate depreciation, so it’s always useful to double-check with a tax professional when it comes to recording deductions.
Types of Fixed Assets
There are many types of fixed assets, depending on the type of business. Usually they are tangible assets that are not traded for cash as a core part of the business. Some examples can include:
- Leasehold improvements
- Real estate
- Office furniture or other property
- Fixed assets are tangible assets that a business acquires to operate, and are often referred to as Property, Plant, or Equipment.
- Business owners can record the purchase of an item as a fixed asset instead of an expense, a process that is called capitalization.
- One month after an item is placed in use, owners can begin to deduct depreciation for the estimated life of the item. Depreciation is deducted from gross profit on the income statement.