There is always a chance, in any companies, that physical fixed assets is unmatched with its accounting book. And this, by the accounting principle and rules, isn’t okay. It should be resolved so that they’re matched. In technical words, the accounting department needs to reconcile its fixed asset record.
There are two possible causes of why fixed asset record is not match with its physical, in majority: (1) fixed assets that are on the books and cannot be located; or (2) fixed assets that are physically there, but not on the books. In most companies, both situations exist.
On the first possible cause, the fixed asset seemingly is missing but the dollar amount shown on the balance sheet has never been written off—therefore the net worth of the company is overstated. As in the second possible cause, at least in theory, it is impossible for significant pieces of fixed assets to be physically present without a corresponding record on the books of account—after all, is it usual that vendors provide gifts in fixed assets to their customers? Of course, they don’t. So, how to resolve those situations? To come to certain solutions, one would need to understand how those situations could come in to their ways so that he/she can prevent such case from happening at the first place. Read on…
How Could a Fixed Asset Not Physically Exist While Its Dollar Value Still in the Book and How To Prevent that From Happening?
Here is the root cause: new assets are acquired, the old assets that they replace simply are not written off the books. But the case could be varies. Consider the followings:
1. All but it is too common that an office manager trades in a black and white copier for a new fancy all-in-one color copier, fax, printer, and scanner. During the installation process of the new copier, the salesman usually make a smart move and says ‘‘If you don’t have any use for the machine, we will give you $150 credit and take the machine off your hands.’’ Since the office manager does not want to spend time disposing of the old machine, he most likely will say ‘‘Go Ahead.’’ If that is the case, ideally, the current net book value of the old asset should be written off. But in many cases this entry is never made, so the books now reflect two units, with only one unit present.
2. Another common case: new HD flat computer screens are just acquired and installed to replace the old non-flat screen. The old screens are moved into a back storage area and forgotten. Then one day the storage area is needed and a supervisor says, “clear out the old stuffs, we’ll never use those again.’’ Whether the old screen are sold or scrapped, the people involved in physical disposition never give a thought to notifying the accounting department—either when the old assets were moved into storage or when the assets were physically disposed of. Consequently, the property accountant—with no reason to make a change in the records—faithfully continues to report the assets as present and she provides for depreciation expense each year.
3. Similar situation is often the case of furniture and fixtures of retail businesses—they’re replaced with new display units, and the old fixtures transferred to other locations. Some display cases could have relatively little cash value it is not long before a store manager or supervisor tells a maintenance staff, ‘‘Get rid of this stuff before we run out of room.’’ Then, the assets are out the door, and again nobody in the central accounting department has the slightest idea of what has happened.
4. Quantity differential isn’t always the case. Overstated-value is even harder to be spotted. Consider a factory expansion, say, the entity wants to expand a 40,000-square-foot warehouse and contracts to add 20,000 square feet of additional space. The original building, built four years ago had cost $4 million or $100 per square foot. The contractor quotes $150 per square foot. Typically, an addition will cost more per square foot than a brand new building. The contract is signed, the expansion completed, and the accounting department capitalizes the $3 million. Now the entity has a 60,000-square-foot building on the books with a total original cost of $7 million or $116.67 per square foot—which is higher than current construction costs for a new 70,000-square-foot building.
How Could Fixed Assets physically Exist While They Are Not In The Book?
In theory, that is impossible. However, in practice, when one takes a complete physical inventory fixed assets, there will be items that simply are there—but the items cannot be located on the existing fixed asset register (books).
What we have been often listen in the school is this: “A good internal control system should stop the loss of asset”. But few discussion in the class give much attention to possibility of a “freaking mysterious” appearance of ‘‘strange’’ assets. In fact, such strange existence of fixed assets is common in the real business practices. While it maybe not as serious as the loss of assets, is itself a symptom of poor controls, INDEED.
So, how such case could be happened?
1. This is the most common happened to a company that use big number of machineries and equipment where many fully depreciated assets will still be in use. If a critical piece of equipment or machine breaks down, it is very common to use a part from another old or even retired, but similar asset, to repair it. Sometimes, a very creative plant engineer will see how to upgrade and improve a piece of equipment—goes to the back storage, gets two old and retired units and then combined into one new higher-volume piece of equipment, effectively custom designing and building the asset for the special purpose. Bang! He now has a “new and strange” machine on the factory floor, running production every day. The physical makeup of this unit in fact be parts from two or more fully depreciated assets, items that may in practice have been retired on the books but physically retained. Two years later an inventory of fixed asset is taken, the new asset found and tagged, but there simply is no record in the financial records of how the piece of equipment got there.
2. The next case is also common and could be happened to any companies that almost always, virtually, has office furniture and fixtures. Individual assets may have been acquired in bulk (e.g., ten desk chairs). Each chair may be worth only $400, but the company has a $3,000 capitalization cut-off. Some accountants capitalize the whole order because it is over $3,000. Other accountants look at the individual chair and say it is not worthwhile trying to control a single $400 chair over a period of years; therefore they charge the total invoice to expense. Now we have ten chairs, scattered throughout the office with no record on the property register. But when a physical inventory is taken often these individual chairs will be picked up as an asset on hand, even though originally it had been charged to expense.
3. Another case would be where a vendor promises to accept a trade-in and reduces the price of the new asset to recognize the trade-in. But in this case the vendor really does not want the asset, just the new order at a small discount representing the value of the trade-in. The vendor invoice shows the trade-in allowance and this time the accounting department retires the old asset from the books, with a corresponding gain or loss. Since the vendor did not take the asset and leaves it with the customer, the company now has a fixed asset, physically there but not on the books.
Again, in practice, number of ways that fixed assets do not physically exist while the dollar values are in the book, is almost unlimited. So is the fixed assets that physically exist but are not in the books. But every one of them has one thing in common: THE ACCOUNTING DEPARTMENT IS NOT NOTIFIED!
What can the company to prevent those from happening?
For all changes affecting fixed assets, it is critical that a system be set up so that the accounting department will be notified, and the property ledger changed appropriately. Desirable as it might seem to leave the initiative up to the accounting department to find out what has happened, in practice this does not work, unless you have a very inquisitive and very aggressive property accountant—and in many companies property accounting is not given the recognition it deserves.
My recommendation is always to set up a system whereby each department manager is responsible for the assets in his or her department. If a periodic audit shows assets are missing, the dollar amount of the missing assets can, and should be, charged to that department’s monthly expenses. Assigning specific responsibility is the only way to induce managers to communicate on a regular basis with the accounting department regarding asset acquisitions, transfers, and dispositions.
Resolving Unmatched Fixed Asset Record with Its Physical
Without a physical inventory and reconciliation nobody in finance even thinks there is a problem. And there are only two methods to ensure the property record really does match the underlying reality of what is out there:
- Method-1, is to take the existing property record, sort it by location, and go out and try to find the assets shown on the listing; and
- Method-2, is to go out and take a complete physical inventory of what is out there.
If Method-2 is chosen then there are two real alternatives:
- Valuation specialists can price out the assets on hand and that becomes the new property register.
- One can try and locate on the existing property register the original entries for the assets on hand as shown by the physical listing; then you write off the missing items and write up the assets which are there but not on the register.
With a good understanding on various ways that the unmatched fixed assets come into their ways, one should be able to carry on this task easily.
Is It Permissible to Net-out The Un Matched Fixed Assets?
Let say you have items on the books you cannot find, and items you find that are not on the books, at least in identifiable form. You have taken an inventory from the existing asset listing, checked off the items you have found, and marked at least preliminarily the fixed assets that are on the record but not physically exist. Also you, on paper, have identified, with a description, the fixed assets you physically found but not on the book. At this point you really have the following three lists:
1. Assets on the books that we have found
2. Assets on the books that we have not found (ghost assets)
3. Assets that we have found that are not on the books (zombie assets)
Sow what you can do with the lists, next?
Step-1. Price out the list of the ‘fixed-assets-on-the-record-but-do-not-physically-exist’, and the corresponding annual depreciation charges. Since you do not know when the items went missing, you do not know how many years of depreciation have been overstated, or in which accounting period the amounts should have been written off. Resolving this will become one of the accounting issues to be solved as part of the reconciliation process.
Step-2. Obtain an estimate of the current fair value of the ‘fixed-assets-that-physically-exist-but-are-not-on-the-record’, which were found. This estimate probably cannot be performed by the accounting staff. Two options offer themselves:
(1) One can ask the purchasing and engineering staff to provide their best estimate.
(2) Alternatively one can engage a valuation specialist, one who deals in machinery and equipment, and ask again for a best estimate.
You do not need, at this point, to have a definitive answer on the specific value of each ‘fixed-assets-that-physically-exist-but-are-not-on-the-record’. What you are striving for is to see how much difference, if any, there is between the dollar amounts on the two lists. In the best-case scenario the dollar value of the ghost assets approximates the dollar value of the ‘fixed-assets-that-physically-exist-but-are-not-on-the-record’. The second and more likely situation is that the dollar value of the ghost assets exceeds the estimated fair value of the ‘fixed-assets-that-physically-exist-but-are-not-on-the-record’, in which case a write off or impairment charge will be necessary.
In the very unlikely situation that the ‘fixed-assets-that-physically-exist-but-are-not-on-the-record’ value exceeds the missing ghost assets, it is unlikely that the company will be able to write up the dollar amount of the fixed assets. The only question then is how best to correct the property register, which I plan to discuss in the coming post.
Accounting9 years ago
Check Payment Issues Letter [Email] Templates
Accounting9 years ago
How To Calculate And Record Depreciation [of Fixed Asset]
Accounting10 years ago
What is Journal Entry For Foreign Currency Transactions
Accounting5 years ago
Accounting for Business Acquisition Using Purchase Method