Bookkeeping – Fixed Asset Purchases (Lesson 49)

Every now and then management authorizes the purchase of a long-term producing asset. This could be a vehicle, piece of equipment or real estate. These purchases are referred to as fixed assets. Recording of these entries is a little different and this lesson explains the entire recording process associated with fixed assets. I’ll explain the definition, account structure, entry process and provide some illustrations to aid in understanding fixed asset purchases.

The next two lessons explain the concept of depreciation and your associated responsibilities. But it all begins with understanding the definition of fixed assets.

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Fixed Assets

The accounting profession defines fixed assets as tangible and long-term purchases. Tangible means physical in nature. Long-term in accounting denotes lasting more than one year. In addition, fixed assets have the ability to be repaired or maintained to extend their life expectancy. Some assets may appear fixed because they are tangible and could last for more than a year but they are consumed or used up over time. Thus they are considered consumables and not fixed assets. Examples include:

Toner Cartridges
Chemicals
Office Supplies
Small Tools Including Medical/Dental Hand Tools

These types of purchases are classified as expenses and not fixed assets.

There is also another common sense issue associated with defining fixed assets and this is cost. Think of the trash can at your desk. It qualifies as a fixed asset. First it is tangible, you can touch it and it has physical form. Secondly, it will last more than a year, many years actually. Finally, it will not be consumed or easily used up. However it costs $15.

The problem with small dollar items like the trash can is that the cost of administering the paperwork associated with tracking fixed assets (depreciation schedules, production analysis, capital investment issues etc.) costs more than the value of the asset. Accountants use a threshold of value to separate these lower cost fixed assets from recorded fixed assets. I encourage small businesses to use $500 as the minimum total price. If less than $500, just expense the item to the most appropriate account. The top three most common expense accounts are supplies, office operations or transportation.

Now for a little helpful suggestion. Suppose the company purchases a group of various items for a distinct purpose. Individually no item exceeds $500 but as a group, the value is indeed more than $500. Also all the items in the group qualify as fixed assets. Here are some examples:

Kitchen appliances for a break room including a small refrigerator, a microwave, coffee maker and utensils
A new office desk along with a chair, floor matt, desk supplies (stapler, calculator, phone station, etc) and a lamp
Meeting room pictures and decorations
Cleaning equipment for a building: buffer, scrubber, buckets, exterior trash cans, brooms, mops, vacuum

How do you address these situations?

In these situations, create one master asset and describe the major items in this group. The total price should exceed $500 as the minimum threshold and consists of several items. Why do it this way?

Two major reasons for accounting for these assets as a group asset justify this entry. First, $500 as a deduction on the income statement in small business does significantly impact the final profit and could lead a reader of the report to the wrong conclusion about performance. Secondly, many local governmental authorities tax business personal property (the items described above). If an auditor discovered the existence of these assets and they are not on the business property list; there is a very good chance the business will incur penalties and interest. One or two items here or there isn’t going to cause action; but if the lack of reporting is obvious, the auditor may take action.

Just remember, fixed assets are defined as tangible, long-term, non consumable purchases in excess of a threshold value (at least $300 and I suggest $500).

Account Structure

The balance sheet is divided into two halves. The upper half contains all assets. The asset side of the balance sheet has three groups of accounts.

Current Assets – Assets that will most likely change status (form) during the upcoming year including cash, accounts receivable, inventory and prepaid expenses.
Fixed Assets – Tangible items with a life expectancy of more than one year (one accounting cycle) including land, improvements, buildings, vehicles, equipment, tools and livestock are referred to as fixed assets.
Other Assets – Tangible and intangible purchases that also will last longer than one accounting cycle and is either amortized (intangibles) or held for future use (lots for construction sites, technology, raw materials, etc.) are classified as other assets.

Within the fixed assets group lies multiple different types of tangible assets. These assets should be grouped based on a similar function. The following are common function driven accounts:

Land – Permanent purchases used by the company on a daily basis including the land for production facilities, office space, storage or legal compliance.
Improvements – This term refers to land improvements excluding heated spaces such as retaining ponds, roads, curbs, landscaping, storage buildings and drainage.
Buildings – This refers to the cost of construction or purchase for the production facilities and office space.
Transportation or Vehicles – This includes trucks, cars, heavy-duty trucks and other Division of Motor Vehicles titled equipment (trailers).
Equipment – Equipment is defined differently in every industry, but in general it refers to the production line system and their associated technology. In an office setting the term ‘Technology’ is used to denote the computers, software and phone system.
Tools or Tooling – This refers to the mobile tools used in business including electronic equipment, garage and welding tools, landscaping hand and power tools, etc. If undecided about whether something purchased qualifies as equipment or a tool, use the level of production as a guideline. A bush hog would be classified as equipment because of the volume of work it can do and its associated cost. Whereas a weed eater only assists and therefore is more in line as a tool.

In small business the account structure is often simple and looks somewhat like this:

Fixed Assets
Transportation (Parent –Child Account)
– Trucks
– Autos
– Trailers
Equipment
Tools (Control Account)

In an office based business it will look like this:

Fixed Assets
Technology – computers, printers, phone system, copier/fax, software, etc.
Furniture/Fixtures – desks, tables, chairs, furniture, wall mounts, shelves, appliances, etc.
Office Systems – mail systems, reference books, file cabinets

Again, group the assets based on their function. In larger operations the financial report (Balance Sheet) will customarily use the acronym PP and E (PP&E). This stands for property, plant and equipment. This is used in lieu of fixed assets as the group title in the assets half of the balance sheet.

Now that you have an account structure it is time to create your source entry.

Entry Process

Many entries that go into the journals involve debits to the income statement accounts, especially into the cost of sales accounts. For purchases of fixed assets it is merely a reclassification of one asset (cash) to another asset (fixed). For example, the owner purchases a meeting room table with chairs for $700. The debit side of the entry is to furniture and fixtures and the credit is to cash. Pretty straight forward for accounting purposes. But there are several issues when purchasing assets including what journal to use, how to identify the asset, and how to enter a complex entry involving financing of the purchases. The following subsections go into more detail related to these issues.

Best Journal to Use

Back in Lesson 3 I explained the various journals that exist in business. One of the journals is called the Fixed Assets Journal where all entries related to fixed assets are recorded. Imagine equipment intensive businesses like site developers, farming, arborists, manufacturing and transportation where equipment utility is the primary driver of sales. A fixed assets journal is a necessity to keep track of fixed assets.

Whereas service based businesses are driven by human labor and therefore fixed asset purchases are not a major component of value on the balance sheet. Here, the general journal can easily serve the purpose of source entry.

In my opinion, if fixed assets exceed 20% of the balance sheet asset total value and/or require more than five entries per year, the bookkeeper should use a fixed assets journal as the source journal. The use of the general journal is an exception to the rule, use a fixed assets journal for all entries related to fixed assets (purchases, depreciation, sales of equipment and disposal).

Proper Asset Identification

It is important to enter a very detail description of the asset purchased. It serves as the basis for determining depreciation and tax classification. The more detail in the description field the better. Most pieces of equipment use a year made, make, model and a serial number. For example a vehicle would be entered in the description filed like this:

2014 Ford E250 Extended Van VIN #ABC1234 with built-in cabinets and floor liner; includes Type C hitch and 1 ton suspension system

Notice the highly detailed description? It is used to justify the cost paid for the particular asset.

It is important to include at a minimum the model and serial number in the description. For more uncommon fixed assets, include features or a code to a file cabinet drawer with an owner’s manual inside.

The goal is to make it easy for the owner or an investor to grasp the value of the respective underlying assets for each of the respective fixed asset group accounts.

Complex Asset Acquisition

Not every fixed asset purchase is a simple cash payment transaction. Most often a full cash payment is rare. This is because a cash payment consumes working capital as explained in Controlling Cash – Lesson 48. It is actually more common to finance the acquisition of the fixed asset. Financing usually involves at least three lines of entry into the fixed assets journal; thus making this a complex entry.

To illustrate the simplest financed purchase and the three corresponding lines of data, suppose management purchases a computer server for $4,000 and finances $3,000 of the purchase price with a bank loan. Here is the entry:

Fixed Assets Journal
Date    ID        Split Account Description DR CR
Today 4104 Technology 2016 HP CR110 4 Array 2TB $4,000
Server w/4 Gigabytes of Ram
& an Energizer Bunny Processor
4104 Cash Check #10118 – HP CR110 2-TB Server $1,000
4104 Long-Term Debt Our Town Bank Note #100108193       3,000
$4,000 $4,000

Notice a part of the entry is one asset (cash) for another asset (fixed) as explained in the first paragraph of the entry process above. However now a financing arrangement is made using a bank-note, a form of long-term debt, to complete the acquisition. This means that liabilities increased by three thousand dollars. But it makes sense because assets increased three thousand dollars too. Remember $1,000 of the price was merely a swap (cash for fixed) of one asset for another leaving $3,000 as the overall assets increase (purchase price less asset swap value).

This form of complex entry doesn’t appear difficult. In reality the entry is much more complex. Let me step up the complexity a bit more.

Same transaction except now in addition to the purchase price the company pays for two more additional items at the same time.

An outside technology firm is hired to install and configure the existing office computer system to integrate with the server.
The bank requires a $200 loan fee to cover costs of paperwork.

Now let’s look at the entry.

Fixed Assets Journal
Date    ID        Split Account   Description DR                  CR
Today 4104 Technology 2016 HP CR110 4 Array 2TB $4,000
Server w/4 Gigabytes of Ram
& an Energizer Bunny Processor
1604 Technology Gary’s Computer Service-Installation
Of HP CR110, Network Config. 2,000
4104 Technology Loan fee from Our Town Bank
Note #100108193 200
4104 Cash Check #10118 – HP CR110 2-TB Server $1,000
1604 A/P – Gary’s Invoice #1604 – HP CR110 Install 2,000
4104 Cash Check #10119 – Our Town Bank, Loan Fee 200
4104 L/T Debt Our Town Bank Note #100108193                3,000
$6,200 $6,200

This entry is more reflective of how it really unfolds in small business. Remember all debits must equal credits. For fixed asset purchases, none of the accounts for posting are income statement accounts (revenue, cost of sales or expenses). The entry only affects the balance sheet.

In the advanced issues section of bookkeeping are additional articles explaining highly complex entries related to fixed asset purchases, disposal and salvage issues. This article is a basic introduction to fixed asset purchases.

Summary – Fixed Asset Purchases

Fixed asset purchases require a different book entry process than other types of economic activity. To understand this process a bookkeeper must first know that fixed assets are tangible, long life assets that are not consumed or used up without the ability to be repaired. To reduce costs of compliance owners should have policies in place identifying minimum thresholds of value to separate fixed assets from expensing the associated cost of purchase.

When recording the entry, use a functional driven account structure to better present the cost values expended for different groups of fixed assets. In addition the bookkeeper is responsible to record the purchase entry using a fixed assets journal. Write a highly descriptive explanation of the item to assist in creating good depreciation and tax schedules. Most entries will require complex multi-line data inputs. By separating fixed assets from other types of entries, financial reports are easier to understand and interpret. Act on Knowledge.

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