Virtually all companies have an investment in fixed assets and the fixed assets are used in the production of goods and services to customers. This investment can range from a single computer to a fleet of cars, for example, or from a leased property to an entire structure of industrial machinery.. For most companies, fixed assets represent a significant capital investment, so it is critical that accounting is applied correctly.
In this case, some factors are important in understanding the topic, such as the fact that fixed assets are capitalized. This is because the asset benefit extends beyond the year of purchase, unlike other costs, which are period costs that benefit only the period incurred. Another important fact is that property, plant and equipment must be recorded at acquisition cost, as the cost includes all expenses directly related to the acquisition or construction and preparations for their intended use. Companies must also adopt a capitalization policy that sets a dollar value limit. Fixed assets that cost less than the threshold amount must be expensed. Finally, additions that increase the service potential of the asset should be capitalized and additions that are better categorized as repairs should be accounted for when incurred.
When dealing with depreciation, for financial reporting purposes, it should be noted that the useful life of an asset may differ from its physical life. The estimated useful life of an asset for financial reporting purposes may also differ from the depreciable useful life for tax reporting purposes. In addition, the purposes of financial reporting and tax depreciation are different, as generally tax methods take advantage of rules that encourage investments in productive assets, allowing for faster write-off, while depreciation for financial reporting purposes is intended to compare costs. with prescription.
Service life can be based on a company's industry standards, based on how long the company expects to use the asset in its operations. Certain assets may be used until they are worthless and disposed of without compensation, while others may still have value to the business at the end of their useful life. If an asset has a residual value at the end of its useful life that can be realized through sale or exchange, depreciation must be calculated on the basis of cost less estimated recoverable value. As estimates, useful lives should be evaluated over the life of an asset and changes should be made where appropriate.
Another important issue in accounting for fixed assets is with regard to their lease or lease. After all, not all fixed assets are purchased by a company. Most companies use both purchase and lease to acquire fixed assets. Under current accounting rules, assets under capital lease are capitalized by the lessee. The depreciable life of assets under a capital lease is generally the useful life of the asset or the term of the related lease.
Property leases are generally classified as operating leases by the lessee. As a result, the leased facility is not capitalized by the lessee. However, improvements made to the property are called improvements in third-party properties and must be capitalized when acquired by the lessee. The depreciation period for improvements in third-party properties is the lesser of the useful life of the improvement or the term of the lease agreement.
Taking into account the criteria that involve fixed assets, some pros and cons are important to remember, such as the recommendation to consider all costs at the time of acquisition, adopt a capitalization policy, estimate the useful life of depreciation based on the useful life estimate of an asset, consider whether the asset will have value at the end of its useful life and base depreciation on cost, less the estimated recoverable amount. It is also important to reassess estimates of useful lives on an ongoing basis, maintain your depreciation records in sufficient detail so that assets can be accurately tracked, and consider the impairment of assets when significant events or changes in circumstances occur.
The recommendations extend to actions that should not be taken, such as using depreciable lives based on accounting rules for financial reporting purposes, ignoring changes in the use or service of an asset as it may be necessary to consider the loss of assets, depreciating automatically a leased asset over its useful life or forgetting to consider insurance record keeping requirements when recording and tracking fixed assets.
What about capitalizing software costs? Are there specific guidelines in accounting standards? In this case, capitalized costs consist of fees paid to third parties to purchase or develop software. Capitalized costs also include fees for hardware installation and testing, including any parallel processing phases. The costs to develop or acquire software that allows conversion of old data are also capitalized. However, the data conversion costs themselves are accounted for when incurred. Training and maintenance costs, which generally represent a significant portion of total expenditure, are accounted for as period costs and upgrade and enhancement costs must be defrayed unless it is likely that they will result in additional functionality.
When a company purchases third-party software, the purchase price may include various elements, such as software training costs, routine maintenance fees, data conversion costs, reengineering costs, and entitlement costs to future updates and enhancements. Such costs must be allocated among all individual elements, based on objective evidence of the fair value of the contract elements.
Property, plant and equipment must also be tested for impairment individually, or as part of a group, when events or changes in circumstances indicate that the carrying amount of an asset may exceed its future gross cash flows. Such circumstances include a significant decrease in the market price of the asset, a material adverse change in the degree or manner in which the asset is being used, a significant deterioration in the physical condition of the asset, accrual of costs that significantly exceed the value originally expected for the acquisition or construction of the asset and an operating loss in the current period and a history of losses indicating that future ongoing losses associated with the use of the asset may occur.
Impairment accounting applies to a situation where a significant asset or collection of assets is not as economically viable as initially thought. Isolated incidents where a particular asset may be impaired are generally not material enough to warrant recognition. In these cases, a change in an asset's estimated life for depreciation may be all that is needed. Impairment is typically a material adjustment to the value of an asset or collection of assets.
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