Learn Fixed Asset Accounting Quickly

For a starter, understanding fixed asset accounting takes somewhat longer time compare to other area of financial accounting. Started from the acquisition cost [initial purchase], understanding the fair market value [FMV] and book value, capitalization of interest, cost incurred during the initial purchase of the fixed asset, cost incurred after the acquisition process, allocating the cost over its life time [depreciation], fixed asset impairment, disposal, and non-monetary exchange.  Thought I have covered all those topics in some separate posts here in detail and packed in practical approach. The fact, I still receive emails asking about how to learn fixed asset accounting quickly.  I can understand for most of them are accounting students. Either they need it for college exam or even preparing for CPA exam. Obviously they need some kinds of module as a quick study reference.

Viewing the high requirement, I decide to construct a pocket book contains some modules in a form of quick study reference that easy to navigate.  As a pocket book, it has to be slim, less text, more formula and journal entries.  Unlike my style that always tend to be comprehensive and details. This pocket book is not. Here I post one of them: “Learn Fixed Asset Accounting Quickly”.

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General Rule

Capitalized amount = Cost of asset + Costs incurred in preparing it for its intended use
Cost of asset = FMV of asset received or Cash paid + FMV of assets given
 
Gifts:

[Debit]. Asset (FMV) = xx
[Credit]. Income = xx
 
Other capitalized costs for assets acquired by gift or purchase:

• Shipping
• Insurance during shipping
• Installation
• Testing

 
Land and Building
 
Total cost:Purchase price + Delinquent taxes assumed + Legal fees + Title insurance
Allocation to land and building – Relative Fair Market Value [FMV] Method:

FMV of land +  FMV of building = Total FMV

Where:

• Land = FMV of land/Total FMV × Total Cost
• Building = FMV of building/Total FMV × Total Cost

Capitalization of Interest on Fixed Asset Purchase

Capitalize on:

• Assets constructed for company’s use
• Assets manufactured for resale resulting from special order
   

Do not capitalize on:

• Inventory manufactured in the ordinary course of business

Interest capitalized:

• Interest on debt incurred for construction of asset
• Interest on other debt that could be avoided by repayment of debt

Computed on:

• Weighted-average accumulated expenditures

 
Costs Incurred After Acquisition Of Fixed Asset

Capitalize if:

• Bigger – the cost makes the asset bigger, such as an addition to a building
• Better – the cost makes the asset better, such as an improvement that makes an asset perform more efficiently
• Longer – the cost makes the asset last longer, it extends the useful life

Do not capitalize:

• Repairs and maintenanceDepreciati

Depreciation Of Fixed Asset 

Basic Terms:

• Straight-line rate = 100% / Useful life (in years)
• Book value = Cost – Accumulated depreciation
• Depreciable basis = Cost – Salvage value

Selection of Depreciation Method

[1]. Use straight-line when: benefit from asset is uniform over life

[2]. Use accelerated when:

• Asset more productive in earlier years
• Costs of maintenance increase in later years
• Risk of obsolescence is high

[3]. Use units-of-production when: usefulness decreases with use

Straight-Line Method

• Annual depreciation = Depreciable basis × Straight-line rate 
• Partial year = Annual depreciation × Portion of year

Double-Declining Balance Method

• Annual depreciation = Book value × Straight-line rate × 2  
• Partial year = Book value × Straight-line rate x 2 × Portion of year

Sum-of-the-Year’s-Digits Method

Annual depreciation = Depreciable basis × Fraction

where “fraction” are:

Partial year:

Units-of-Production Method

• Depreciation rate = Depreciable basis/Total estimated units to be produced (hours)
• Annual depreciation = Depreciation rate × Number of units produced (hours used)

Group or Composite Method

• Based on straight-line

Gains or losses not recognized on disposal:

[Debit]. Cash (proceeds) = xx
[Credit]. Accumulated depreciation (plug) = xx
[Credit]. Asset (original cost) = xx

Fixed Asset Impairment

Occurs if undiscounted future cash flow less than asset carrying amount from events such as:

• A decrease in the market value of the asset
• An adverse action or assessment by a regulator
• An operating or cash flow loss associated with a revenue producing asset

When an impairment loss occurs:

Asset is written down to fair market value (or discounted net cash flow) with the following journal entry:

[Debit]. Loss due to impairment = xx
[Credit]. Accumulated depreciation = xx

 
Note that test for impairment (future cash flow) is different from write-down amount (net realizable value)

Application of Impairment Rules

Example 1:

Asset carrying value = $1,000,000
Undiscounted future cash flow expected from asset = $900,000
Fair market value of asset = $600,000

Impairment exists = $900,000 expected cash flow less than $1,000,000 carrying amount
Write asset down by $400,000 ($1,000,000 reduced to $600,000)

 

Example 2:

Asset carrying value – $800,000
Undiscounted future cash flow expected from asset – $900,000
Fair market value of asset – $600,000

No impairment adjustment – $900,000 expected cash flow exceeds $800,000 carrying amount

Disposal of Property, Plant, & Equipment  [PP&E]

[Debit]. Cash (proceeds) = xx
[Debit]. Accumulated depreciation (balance) = xx
[Debit]. Loss on disposal (plug) = xx
[Credit]. Gain on disposal (plug) = xx
[Credit]. Asset (original cost) = xx

A disposal in involuntary conversion is recorded in the same manner as a sale.

Non-monetary Exchanges

On Debit side: Cash (amount received)
[Debit]. Asset – New (FMV) = xx
[Debit]. Accumulated depreciation (balance on old asset) = xx
   
On Credit side: Loss on disposal (plug)
Cash (amount paid)
[Credit]. Gain on disposal (plug) = xx
[Credit]. Asset – Old (Original cost) = xx

Fair Market Value

Use fair value of asset received [or] Fair value of asset given + Cash paid – Cash received

 
Exception

Applies to exchanges when:

• FMV is not determinable
• Exchange is only to facilitate subsequent sales to customers (e.g. ownership of inventory in one city is swapped for similar inventory in another to facilitate prompt delivery to customer in distant city)
• Transaction lacks commercial substance (risk, timing, and amount of future cash flows will not significantly change as a result of the transaction).

Loss – FMV of asset given < Carrying value of asset given:

[Debit]. Cash (amount received) = xx
[Debit]. Asset – New (FMV) = xx
[Debit]. Loss on disposal (plug) = xx
[credit]. Cash (amount paid) = xx
[Credit]. Asset – Old (carrying value) = xx

Gain – FMV of asset given > Carrying value of asset given: Gain recognized only when cash received 

FMV of asset given – Carrying value of asset given = Total gain × Percentage = Gain recognized

Where:

• Percentage = Cash received / Total proceeds [Cash + FMV of asset received]

[Debit]. Cash (amount received) = xx
[Debit]. Asset—New (plug) = xx
[Credit]. Gain on disposal (computed amount) = xx
[Credit]. Asset—Old (carrying value) = xx

No gain recognized when cash paid or no cash involved:
 
[Debit]. Asset – New (plug)  = xx
[Debit]. Accumulated depreciation (balance on old asset) = xx
[Credit]. Cash (amount paid) = xx
[Credit]. Asset – Old (original cost) = xx

If you like this fixed asset quick reference, you may want to read: Learn Intangible Assets in 1 Minute too.