ACCOUNTING FOR FIXED ASSETS

1.0INTRODUCTION

According part 1 of the Statement of Accounting Standard (SAS) 3, property, plant and equipment, generally referred to as fixed assets, are those tangible resources of an enterprise which are employed in its operations. In many enterprises, these assets are grouped into various categories such as land and buildings, plant and machinery, equipment, furniture, fixtures and fittings, vehicles, etc. This Unit deals with the introductionary aspects of accounting for fixed assets and related issues.

2.0OBJECTIVES

At the end of this unit, you should be able to:

1. appreciate the concept of fixed assets understand 
2. ways of accounting for fixed assets differentiate 
3. between leased and owned fixed assets 
4. appreciate the need to provide for fixed assets depreciation. 

3.0MAIN CONTENT

3.1Accounting for Fixed Asset

3.2Relevant Concepts Surrounding Fixed Asset

Fixed assets are tangible assets that have been acquired or constructed and held for use in the production or supply of goods and services and may include those held for maintenance or repair of such assets; and are not intended for sale in the ordinary course of business.

Leasehold rights over assets which meet the above criteria may also be treated as property, plant and equipment in certain circumstances. The fair value of a fixed asset is the amount for which an asset could be exchanged between a knowledgeable willing buyer and a knowledgeable willing seller in an arm’s length transaction, while its net book value is the amount at which an asset is carried in the books less the related accumulated depreciation.

The useful life of a fixed asset is the shorter of (a) the predetermined physical life and (b) the economic life during which it could be profitably employed in the operations of the enterprise. The recoverable amount of a fixed asset is that part of the net book value of a fixed asset that an enterprise can recover in the future through depreciation of the item including its net realizable value on disposal.

SELF ASSESSMENT EXERCISE 1

1. What do you understand by the term fixed asset? 
2.  Differentiate between Leasehold and Freehold fixed asset. 

3.3 Valuation of Fixed Assets

Fixed assets are stated in the financial statements of reporting entities at cost (usually historical cost) or valuation less accumulated depreciation. The cost is normally a combination of purchase price and other expenses, including installation expense, up to the stage of usage of the assets. Fixed assets on lease are accounted for strictly in accordance with their legal form as fixed assets. The relevant assets are purchased in the name of an enterprise and subsequently leased to customers as operating leases.

SELF ASSESSMENT EXERCISE 2

1. Why is fixed asset cost a combination of two or more variables? 2. What is legal form? 

3.4 Depreciation Policy of Fixed Assets

Depreciation charged on fixed assets is usually calculated by most businesses on the straight-line basis to write off their costs over their estimated useful lives at different annual rates.

3.5 Methods of Recognizing Fixed Assets and Liabilities Assets are resources controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. Liabilities, on the other hand, represent obligations of the enterprise arising from past events, settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

For the purpose of recognizing assets and liabilities in the balance sheet, IAS 5 provides recognition:

1. When there is probability that a future inflow or outflow of benefit to or from the entity will occur; and 
2. When the asset or liability can be measured as a monetary amount with sufficient reliability. 

In circumstances where legal principles contradict the financial realities of a transaction, the substance of the transaction should be accounted for while its legal principles are ignored. Accountants are often faced with this conflict in certain transactions such as:

3.5.1 Sale and Repurchase Agreement

These arrangements occur where an asset is sold by the seller to a buyer on terms that the seller repurchases the asset from the buyer at a future date. This transaction has two possible interpretation of either a secured loan or a sale-lease back. If the arrangements provide that the seller retains right to determine asset’s use while the buyer only receives return (secured loan) the asset will only be recognized in the books of the seller. The transfer of title by way of purchase is ignored.

3.5.2 Finance Lease Arrangement

Where the transaction resembles a finance leasing arrangements i.e. the ownership title passes to the buyer, the assets shall be recorded as that of the buyer.

SELF ASSESSMENT EXERCISE 4

1.  What are the IAS 5 provisions for recognizing assets and liabilities? 2. Differentiate between purchase of asset and its lease. 

3.6 Cost of Self-Constructed Fixed Asset

Enterprises sometimes self-construct some fixed assets for their own use, usually to save costs, meet unique specification or utilize idle capacity.

The cost elements of self-constructed fixed assets are costs of materials, labor and overheads that are directly attributable to the construction less any trade discounts, rebates or internal profits. Interest costs which are attributable to the period of constructing the item of fixed asset are sometimes added to its cost. Other costs, including cost of inefficiency in production of self-constructed items of fixed assets such as the idle capacity, industrial disputes and similar costs, are expensed in the period in which they arise.

3.7 Components of Fixed Asset Cost

SAS 3 provides that the cost of an item of fixed asset comprises: its purchase price, including import and non-recurring levies (e.g. development levies, consent fee, etc) and any directly attributable costs of bringing the asset to its location and working condition for its intended use. Any trade discount and rebates are deducted in arriving at the purchase price.

SELF ASSESSMENT EXERCISE 5

1.  Discuss the process of determining self-constructed fixed asset cost. 
2.  Comment on SAS 3 provision on composition of fixed asset cost.  

Illustration One

The elements of cost for Land and its Improvements:

1. Original purchase price 
2.  Broker’s or Estate Agent’s commission 
3.  Legal fees for examining, recording and securing title 
4.  Cost of survey 
5.  Cost of obtaining vacant possession 
6.  Payment of non-recurring levies on the land at date of purchase if payable by the purchaser. 

Cost of demolishing any old structure (net of salvage) is sometimes added to the cost of land and sometimes to the cost of the building on the site.
Some additional costs may be incurred subsequent to purchase in order to improve the land for the intended purpose. Such costs, which are often capitalized, include the following:

1.  Filling and draining 
2. Clearing 
3.  Landscaping 
4.  Grading and sub-dividing 
5. Access road, etc 

Illustration Two

The elements of cost for Buildings:

1.  Original purchase price or cost of construction. 
2. Cost of remodeling, reconditioning, or altering a building to render it suitable for its intended use. 
3.  Cost of excavating or filling of land for the specific building. 
4. Foundation costs such as rock blasting, piling and rechanneling of canal or underground stream. 
5. Cost of building permits. 
6.  Payment of development levies on the building at the date of purchase if payable by the purchaser. 
7.  Professional fees for design, supervision and management of the construction. 
8.  Cost of temporary buildings used during the construction period less disposal proceeds. 

The cost of ancillary building plants such as lifts and air-conditioning systems, etc, are sometimes recorded separately from the cost of the building.

Illustration Three

The elements of cost for Plant and Equipment:

1. Original purchase price or cost of construction. 
2.  Freight, import duties and handling charges. 
3. In-transit insurance charges. 
4.  Taxes and levies. 
5. Cost of preparation of foundations, insulations, protective and other special devices. 
6. Commissioning, including testing and running-in costs in preparation for use. 
7. If the item is a second-hand one, the cost of refurbishing it for the intended use. 

4.0 CONCLUSION

Fixed assets constitute a great percentage of the total assets value of business enterprises, especially manufacturing businesses. The value of each item of fixed asset needs to be determined as critically as possible so that the asset is not over-valued or under-valued. Fixed assets are subject to wear and tear, passage of time and other reasons why fixed assets’ value would depreciate. The depreciation expense has to be determined and deducted from the book value of the asset with a view to ascertaining the net book value of the asset at any given time. This Unit is an attempt at highlighting all these issues in an introductory way for the students to achieve the objectives set above.

5.0 SUMMARY

This Unit has discussed the concept of fixed assets and related issues, valuation of fixed assets, depreciation policy and how it is determined, components of fixed asset costs and cost of self-constructed fixed assets. The Unit is strong follow up to the provisions of the Statement of Accounting Standards (SAS) 3, issued by the Nigerian Accounting Standard Board (NASB).