The Definition of Fixed Assets

Any tangible item not consumed within one accounting cycle (typically a year) and providing long term utility is referred to as a Fixed Asset. Traditional images include manufacturing equipment, tools, transportation vehicles, buildings and utility related systems (sewage systems, power grids, power plants and dams). In accounting, these assets are recorded to the balance sheet as ‘Fixed Assets’. For very large corporations the line item is referred to as ‘Buildings and Equipment’ or some other generic term identifying capital expenditures for high dollar cost items. 

Classification as a fixed asset requires the item pass two tests. The first test is tangible in nature. This means it must have physical characteristics. Such items as patents or research and testing do not pass the test due to a lack of physical existence. In accounting terminology, these are referred to as intangibles and are recorded in a different class of assets. Examples of tangible items include tools, site development costs (pavement, curbing, light poles, even trees), structures and trucks.

The second test is the utility period. This is more commonly referred to as the consumption period. If the item will be consumed or used over an extended period of time i.e. longer than the traditional accounting cycle (a calendar year) it may pass the 2nd part of the test. But we need to be clear here. If the item is purchased and is used up as a part of the product you sell or service you render, it is not a fixed asset, but inventory in nature. The following are examples of tangible and consumable items, therefore not meeting both tests to be classed as fixed assets:

  • Toner Cartridge – purchased for use in your office printer, it will most likely last more than one year, but because it is used up providing documents as a part of the service you render, it is not a fixed asset. Remember it passes the first test of tangible but technically it is considered consumed for the second test.
  •  Raw Resources – you are a concrete provider, you purchase 200 railroad cars of sand and pile it up out in the work yard. This sand is physical in nature i.e. tangible and will be used over the next 18 months. Technically it passes test two of more than one accounting cycle. The reality is that it is a part of the product you provide; therefore it is inventory and not a fixed asset.
  • Chemicals, Lubricants, Gases – these items are used over an extended period of time in the manufacturing or service you render; although tangible, they are consumable and therefore should be classed as supplies in the inventory area of your balance sheet.

For the small business entrepreneur the definition requires modification to simplify accounting. There is a tenet of accounting that basically states that the cost should not exceed the benefit derived. For any fixed asset, there is cost associated with ‘carrying’ the asset on the books of record. Fixed Assets are recorded in a special ledger or spreadsheet as fixed assets and subdivided into groups as illustrated below:

Office Equipment                                            $Z,ZZZ
Transportation                                                 ZZ,ZZZ
Manufacturing (Tooling)                              ZZZ,ZZZ
Buildings/Structures                                     ZZZ,ZZZ
Land                                                                ZZ,ZZZ

Noticed that this looks like it is organized from the overall lowest cost to the most expensive, but in reality the accountant organized this section based on life expectancy from short life value of office equipment to the never ending life of land.  Any reasonable organization format is acceptable as long as the reader can understand the report. On the balance sheet the entire group can just be called ‘Fixed Assets’ or you can detail this into subgroups like above.

Now back to the tenet of benefit must exceed the cost. The carrying costs means that an accountant will review the items each year for calculating depreciation and will most likely have to confirm the existence of the assets via an inventory of the items. A small businessman shouldn’t spend his time dealing with these types of petty issues as it relates to low cost items. Some items meet both tests of tangible and long life, but it is unrealistic to record them as fixed assets because of the costs to maintain them on the books would exceed the benefit associated with that cost to maintain them on the books. Here are two examples:

The Desk Trash Can – notice it meets both tests! It is not a part of the item sold or service rendered. But you need to be realistic because you don’t want to record a $13 item to your fixed assets ledger. It should be expensed to the profit and loss statement or placed in a large group asset called ‘Office Auxiliary Equipment’ and combined as one line item in the subgroup of Office Equipment (Desks, Computers, Printers, Etc.). This subgroup is generally created when you first start business and purchase everything from staplers to office signage. Group it all together as one line item and it is included in the Office Equipment section of Fixed Assets. Therefore, Office Equipment has the following subgroups:

  •  Technology (Computers, Servers, Wiring, Etc.)
  •  Phones and Phone System
  •  Desks and Furniture
  •  Cabinets, Storage Systems, Bookcases
  •  Software (See Below)
  •  Office Auxiliary (staplers, trash cans, hole punches, tape dispensers, the cart, books)
  • Tools – this one is more financially based than anything else. For some reason they have a tendency to disappear, I don’t why, they just do. Everything from hand tools to extension cords etc. should generally be expended. However, sometimes you will buy tooling systems such as die sets, drill bit systems, etc. We are talking about some serious dollars here and these should be recorded as fixed assets in the equipment group. Odds are that you will keep a closer eye on a tap and die set that costs $4,200 used with your CNC machine than the $19 hammer.

The key is to create a dollar value threshold. Anything costing less than $500, but still passes the test of tangible and long life should be expended. However, if you buy a group of items at one time and the combined total is more than $500; combine the items as one line item in the ledger and record them as a fixed asset. An example is purchasing the refrigerator, microwave, coffee pot, toaster, and stove for the office kitchen.

Yes, all of the above comply with Generally Accepted Accounting Principles and the Internal Revenue Code. 

Software – this is one of the exceptions to the rule above. For some strange reason, the  accounting profession has decided that this is a fixed asset. However, the definition was modified because the ever changing world of software providers. They have gotten to the point of reproducing this stuff on an annual basis and requiring the consumer to keep upgrading to stay in compliance. The accounting world and the IRS agree that if you purchase off the shelf type of software, it should be immediately expensed. If you purchase custom designed or industry specific software then this should be classed as a fixed asset in your Office Equipment section. I know, it is not tangible in nature, but accountants figured that since it is used regularly (daily) and it generally requires maintenance like equipment, it should be considered tangible. I don’t make the rules, and often I don’t think the rules are the best, but consistency is important in our profession. Software is considered a fixed asset.

In summation, fixed assets must meet two tests. First is tangible in nature and the second test is a long life or utility period. By setting dollar value thresholds and using some common sense, a small business entrepreneur will not get bogged down with the accounting requirements and can stay focused on making a profit. Act on Knowledge.

Value Investing

Do you want to learn how to get returns like this?

Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

There are four key principles used with value investing. Each is required. They are:

  1. Risk Reduction – Buy only high quality stocks;
  2. Intrinsic Value – The underlying assets and operations are of good quality and performance;
  3. Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
  4. Patience – Allow time to work for the investor.

If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above. 

Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:

  1. Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
  2. Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
  3. Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.

Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:

  • Lessons about value investing and the principles involved;
  • Free webinars from the author following up the lessons;
  • Charts, graphs, tutorials, templates and resources to use when you create your own pool;
  • Access to existing pools and their respective data models along with buy/sell triggers;
  • Follow along with the investment fund and its weekly updates;
  • White papers addressing financial principles and proper interpretation methods; AND
  • Some simple good advice.

Value Investment Club

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