What are Fixed Assets?
Fixed Assets are resources expected to provide long-term economic benefits that are expected to be fully realized by the company across more than twelve months.
- What is the definition of fixed assets?
- What are some examples of fixed assets?
- Are fixed assets and non-current assets the same?
- Why are fixed assets depreciated in accounting?
Table of Contents
Fixed Assets Definition
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, fixed assets are considered long-term investments for the company.
Companies purchase 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 (i.e. fixed assets) on the balance sheet.
- Current Assets: Cash & 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
- Vehicles (Cars, Trucks)
Unlike current assets, non-current assets (i.e. fixed assets) are typically illiquid and cannot be converted into cash within twelve months.
Examples of Fixed Assets (Non-Current)
The most common examples of fixed assets found on the balance sheet include:
|Property, Plant & Equipment (PP&E)||
Fixed Assets Accounting Treatment
Under U.S. GAAP, fixed assets are typically capitalized and expensed across their useful life assumption on the income statement.
Tangible fixed assets (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 useful life assumption of the asset.
The rationale behind depreciating fixed 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 as opposed to depreciation.
Land and Goodwill Accounting Treatment
Under U.S. GAAP, not all non-current assets are depreciated or amortized.
- Land: Land is categorized as a long-term fixed asset on the balance sheet but 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.
PP&E (Fixed Asset) vs Inventory
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 (fixed) asset.
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.
In contrast, purchases of PP&E occur far less frequently since fixed assets like buildings and machinery are utilized for long durations.
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.
On the other hand, 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.
The fixed asset turnover ratio calculates the efficiency at which a company can generate revenue using its fixed assets (PP&E).
The formula for calculating the fixed asset turnover ratio divides net revenue by the average fixed assets (i.e. the average PP&E balance between the current and prior period).
Fixed Asset Turnover Formula
- Fixed Asset Turnover Ratio = Net Revenue / Average Fixed Assets
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.