Fixed Assets

What are Fixed Assets in Accounting?

In accounting, fixed assets, often used interchangeably with the term “Non-Current Assets”, are assets expected to be utilized over the long term (>12 months).

Since the potential benefits are not fully realized in twelve months, non-current assets are considered long-term investments for the company.

Companies purchase non-current assets – resources that provide positive economic benefits – to generate revenue as part of their core operations.

Moreover, assets are categorized as either current or non-current assets on the balance sheet.

• Current Assets: Cash and Cash Equivalents, Accounts Receivable, Prepaid Expense, Inventory
• Non-Current Assets: Property, Plant & Equipment (PP&E), Intangible Assets, Goodwill

Within the PP&E line item, various types of fixed assets are included, such as the following:

• Buildings and Property
• Land
• Equipment
• Machinery
• Vehicles (Cars, Trucks)

What are Common Examples of Fixed Assets?

The most common examples of non-current assets found on the balance sheet include the following:

Why are Fixed Assets Capitalized?

Under U.S. GAAP reporting, fixed assets are typically capitalized and expensed across their useful life assumption on the income statement.

Tangible non-current assets (i.e. PP&E) are recognized on the income statement through depreciation, which is the concept of allocating the original purchase amount (i.e. capital expenditure) across the estimated useful life of the asset.

The rationale behind depreciating non-current assets stems from the matching principle, as depreciation attempts to match the expense from the purchase of the fixed asset in the same period when the corresponding revenue was generated.

The accounting treatment of “depreciating” certain intangible assets is conceptually identical to depreciating tangible assets. However, the “depreciation” expense is called amortization.

However, under U.S. GAAP, not all non-current assets are depreciated or amortized.

• Land: Land is categorized as a long-term asset on the balance sheet, yet land is assumed to have an indefinite useful life under accrual accounting, so depreciation of land is prohibited.
• Goodwill: Goodwill is an intangible asset that captures the premium paid over the fair value of an asset – and rather than being amortized, the carrying value of goodwill for public companies is tested for impairment on an annual basis.

Fixed Asset vs. Inventory: What is the Difference?

Inventory and PP&E are both considered tangible assets, meaning that they can be physically “touched”.

Yet, inventory is classified as a current asset, whereas PP&E is treated as a non-current asset.

Unlike current assets, non-current assets are typically illiquid and cannot be converted into cash within twelve months.

• Inventory: The distinction between inventory and PP&E is that once a company purchases inventory, they are cycled out/sold rather quickly (<1 year). Hence, a company typically must replenish its inventory multiple times a year. Further, a company’s inventory, such as parts and components, is far more likely to be able to be sold in the market and be converted into cash post-sale.
• PP&E: In contrast, purchases of PP&E occur far less frequently since assets such as buildings and machinery are utilized for long durations. Unlike inventory, PP&E is less likely to be sold (and liquidated into cash proceeds) because of the limited number of potential buyers in the market.

Fixed Asset Turnover Ratio

One method to measure how efficiently a company utilizes its fixed asset base is the fixed asset turnover ratio, which measures the efficiency at which a company can generate revenue using its PP&E.

The formula for calculating the fixed asset turnover ratio divides net revenue by the average non-current assets, i.e. the average PP&E balance between the current and prior period.

Generally, the higher the fixed asset turnover ratio, the more efficient the company is since it implies more revenue is created per dollar of fixed assets owned.