Fixed Assets, Provision for Depreciation, and Disposal
In accounting, a distinction is made between fixed assets and current assets.
Fixed assets refer to those assets whose benefits are to be derived over a number of years depending on the useful lives of the asset. Examples of fixed assets are land and building, plant and machinery, motor vehicles.
Current assets are assets whose benefits are derived within the accounting period or in the next accounting period.
Whether or not an asset is defined as fixed or current will depend on the nature of the business. If the business deals with the item in the normal course of business then it is taken as a current asset. If it is an item that can produce future benefits and can be used over a number of years then it is regarded as a fixed asset.
Thus, an investment trading company would consider investments in stocks and shares as short-term investments and hence treat such as current assets. In any other line of business, investment in a subsidiary company would be classified as a fixed asset on account of its long-term nature.
Depreciation, and Provision for Depreciation of Asset
Fixed assets, unlike current assets, are subject to depreciation. Depreciation is the difference between the cost of an asset and its sale or scrap proceeds on disposal.
Depreciation is spread over the life of an asset by one of the following methods in order to match the cost of the use of that asset to the revenue earned by it.
Main methods of calculating annual depreciation charges are:
1. Straight line - The depreciation is a fixed charge every year calculated as a percentage of the original cost, as follows:
Cost of asset less estimated residual value at the end of useful life
estimated useful life (in years)
2. Reducing Balance - Depreciation is calculated as a fixed percentage of the written down value of the asset at the beginning of the year.
3. Revaluation - Used for assets for which detailed records cannot conveniently be maintained, e.g. loose tools and other small items of equipment. It is calculated as follows:
Value of asset at beginning of year + additions during the year - value of asset at end of year.
Accounting entries to record provision for depreciation:
Debit Profit & Loss Account
Credit Provision for Depreciation of (asset) Account -- (with the annual charge for depreciation)
The annual charge for depreciation is an attempt to match a proportion of the cost of an asset to revenue earned by it in a year. It is a bookkeeping entry. It does not involve any payment of the money; it is a non-monetary (non-cash) item in the Profit and Loss account.
In the balance sheet, deduct the balances on the Provision for depreciation accounts from the relevant assets in order to show the net book (or written down) values of the fixed assets.
The net book value of an asset, as shown in a balance sheet, is the balance of the original cost not yet written off against revenue; it is the amount being carried forward at the date of the balance sheet to be written off against future revenue from that asset. It is not intended to represent what the asset is worth; still less is it a statement of what the asset will fetch if sold.
Disposal of Fixed Assets
(Profits and losses on disposal of fixed assets frequently have to be calculated in examination questions.)
Proceeds of disposal - (original cost - aggregate depreciation to date of disposal)
i.e. Proceeds of disposal - written down value at date of sale
= profit / (loss)