A company’s Balance Sheet comprises of Assets, Liabilities and Shareholder’s Equity.
The Assets are classified into Current & Non-Current Assets with Non-Current Assets further classified into Fixed Assets, Intangible Assets, Long Term Investments and Deferred Charges.
What are Fixed Assets?
Fixed Assets are long-term tangible piece of asset expected to last, or be in use for more than one year and are used in the course of daily business operations for the production of or supply of goods or services. They can also be used for rental to third parties and provide economic benefits over a period of time. They are usually held for a period greater than one year i.e. their effective useful life is greater than one year. Typically, fixed assets have a physical form and are reported in the Balance Sheet as Property, Plant and Equipment(PP&E).
Fixed Assets lose value as they age. Their regular usage leads to wear and tear of the asset which reduces it’s overall value. The said reduction in value i.e. Depreciation is charged over the useful life of the fixed asset.
At the end of its useful life, the asset may be sold and the company may receive a very small amount for it, but in it’s books of accounts the company has written down the asset.
Recording Fixed Assets on the Balance Sheet
On a balance sheet, these assets are recorded at their book value (purchase price less depreciation). If the Market Value of the Asset falls below its Net Book Value, then the Asset is subject to an impairment cost. It implies that the prevailing value of the asset on balance sheet is reduced to match it to it’s market value reflecting it had been overvalued compared to market price, and this reduced value shall be it’s fair value.
An acquisition or disposal of fixed assets leads to an outflow or inflow of cash, which is reflected in the Cash Flow Statement of the company under the head of Investing Activities.
Financing of Fixed Assets
With respect to their reporting in the financial statements, Fixed Assets are reported in the Balance Sheet at the end of the accounting period which also reflects the depreciation charged on them. The amount of depreciation is a charge on the company’s profits and thus reported in the Income Statement.
Generally, fixed assets are financed by non-current liabilities which ensures that there is no hindrance in the revenue generation activities of the company.
Valuation of Fixed Assets
With the prevalence of various accounting standards and practices like US GAAP, IFRS, IndAS etc in various parts of the world, it becomes necessary for the company to choose and adopt accounting standards that give a true and fair value of it’s financial position. Accurate financial reporting, business valuation and a thorough financial analysis is only ensured if the company reports its assets at fair values, with proper explanation in the notes to accounts with respect to the determination of those figures.
Fixed Assets are extremely important for Manufacturing Industries which are capital intensive, and thus remains an important avenue for investment for the company after every 5-10 years.
Companies during their growth phase usually witness an initial decrease in cash inflows due to heavy cash outflows on account of investment in fixed assets, thereby playing an important role in it’s growth.