Fixed assets are my bread and butter. It was one of the first jobs I ever did when I was working in manufacturing. I enjoyed this job. I guess the company knew I enjoyed it because they kept me at it for a good while. Fixed assets are very basic in concept but a bit more complicated in practice. Depending on the size of the company you work for you may find it quite difficult and complicated.
First off let’s get through the 101 basics. So, generally a fixed asset will fall under the category of capital assets. The reason we don’t call them all capital assets is that some capital assets are not tangible. These are things such as patents and goodwill. Fixed assets are capital assets that are tangible. So what qualifies? Well you really need to find out how your company defines a fixed asset because some companies will vary. But the general idea is this: Fixed assets are tangible assets that will provide value for more than one year. If we break down the definition we will see the details. Notice I didn’t say an asset that will last for more than one year because sometimes we may plan to sell it within a year. Another scenario is if we plan to keep it more than one year but the average life of the asset is less than a year. We will then need to assume that it will not be for one year.
Expense vs. Capital
The biggest debate in manufacturing concerning fixed assets is with capital verses expense. An expense item is something that the company will recognize on the books today (or this month). A capital item is something the company will recognize on the books little by little over a period of time. This is really only a debate in larger companies due to the cash flow. So if you remember the differences between the cash flow statement and the income statement here is one of the reconciling items. I’ll give you an example. If you buy a building and it costs you 1,000,000 dollars then you will definitely need the cash to pay for it. If you use the building this year and create 400,000 dollars of income then your net cash flow will be a negative 600,000. But does this really indicate what happened this year? What about next year? If you keep everything else constant you will notice that you will have a net income of 400,000. This doesn’t smell right for accountants. We know that we need to match burden or expense with the income that it helps generate. So in this case we would need to figure out how much burden is really being incurred this year. We have some guidelines there. Buildings are generally assumed to last 40 years. So in a simple sense we should divide 1,000,000 by 40 = 25,000. Therefore the actual expense for this year would be 25,000 instead of 1,000,000. This would give us a much more realistic 375,000 net income for the year.
The real argument however, comes with the way that company’s budget. If a manufacturing company decides to give the capital budget to the same owners that hold the relevant expense budget there would be no problem. But this is almost never the case. Obviously it would be a little awkward to do so. I mean imagine an operations manager that has an annual 2,000,000 dollar budget and a 1,500,000 capital budget. Obviously they would want to pull back on capital and probably not worry about expense because that would be such a small portion of their overall responsibility. Then the factory would lose track of spending. Instead, they give a 500,000 budget to the operations manager and let them debate which items are worth purchasing.
The problem starts when the operations manager wants to buy an item that they believe will fall under the capital budget. So let’s say it costs 250,000. Well as the capital accountant you will look at the purchase and if perhaps it is really made up of tiny purchases that do not meet the capital threshold it will all have to be expensed. And guess where the expense dollars will go… right in to the operation manager’s expense budget. Obviously the operations manager does not want to spend 50% of their annual budget on one project.
This decision will almost fully rest on the back of the capital accountant. Your job will be to ensure that the correct decision is made regardless of the political implications of whose budget is affected. Keep this in mind and read up on all the rules to make sure that you can be trusted when making a decision.