Asset held with the intention of being used for the purpose of producing goods or providing services and is not held for sale in the normal course of business is known as fixed assets.
Fixed assets are shown on the balance sheet at its historical cost less accumulated depreciation.
Cost of fixed assets
Cost of fixed asset is the purchase price and any thing that is necessary to make it ready for production. This means cost includes invoice price of the fixed asset and all expenditures involved in the acquisition and getting it ready for use. The total costs of acquiring and putting it into use should be capitalized.
For instance, in case of machinery, major spares, standby equipment and spares which can be exclusively used only in connection with particular equipment are capitalized as cost of machinery.
Here are certain type of costs that is capitalized along with the purchase or invoice price;
- Initial Delivery & Handling
- Installation & Assembly Cost
- Cost of testing
- Cost of site preparation
Please remember, only those costs are to be capitalised which are specifically attributable to construction or incurred for bringing the item to use. Costs like administrative expenditure, selling and other general overheads are not capitalised.
When the fixed asset is in working condition, you need to stop capitalizing and start charging depreciation.
One of the general accounting principle is that the total cost of acquisition should be spread over the expected useful life of the asset in such a way that it allocates cost as equitably as possible to the periods during which services are obtained by the owner from the use of the asset. This entire process is known as depreciation accounting.
In simplified terms, depreciation accounting is a system of accounting which aims to distribute the cost, less salvage (if any), over the estimated useful life of the fixed assets in a systematic and rational way.
Depreciation is charged to the profit and loss account every year. Accumulated depreciation is shown on the balance sheet by subtracting it from the cost of fixed assets. The main purpose of charging depreciation to profit and loss account is that costs incurred in the purchase or construction of the fixed asset should spread over the useful life in which benefits arises.
Examples of fixed assets;
- Plant and machinery
- Furniture and Office Equipment
Please note, land is not depreciated and its cost lasts in our theoretical business model forever