What Is a Fixed Asset? Definition, Value & Depreciation

Businesses use resources called assets, which are items a company controls that are expected to provide future economic benefits. These assets are fundamental to operations, enabling revenue generation and sustaining activities. Assets are reported on a company’s balance sheet, reflecting their value and contribution to the overall financial position.

Understanding Fixed Assets

Fixed assets are tangible, long-lived resources a company uses in its operations and does not intend to sell. They possess physical substance and are expected to provide economic benefits for more than one accounting period, typically exceeding one year. These assets provide the necessary infrastructure and tools to produce goods and services.

Common examples of fixed assets include buildings, machinery, vehicles, land, and office equipment. Unlike current assets, which are easily convertible to cash within a year, fixed assets are not liquid. These assets, often referred to as property, plant, and equipment (PP&E), are held for their operational utility.

Initial Recognition and Valuation

Companies initially record fixed assets on their financial statements following the cost principle. This principle dictates that assets should be recorded at their original cost at acquisition. The original cost includes the purchase price and all expenditures necessary to acquire the asset and prepare it for its intended use.

Additional costs can include freight, sales tax, transportation, installation, and testing fees. For example, if a company purchases machinery, the cost includes the machine’s price, shipping, and any expenses for setting it up and ensuring it functions correctly. This total initial cost becomes the asset’s “carrying value” on the balance sheet.

Depreciation: Allocating Cost Over Time

Depreciation is an accounting method used to systematically allocate the cost of a tangible fixed asset over its estimated useful life. This process reflects the gradual reduction in an asset’s value due to wear and tear, technological obsolescence, or other factors. Depreciation is an accounting allocation, not a measure of the asset’s market value, and it helps match the asset’s cost with the revenues it generates.

Several factors are considered when calculating depreciation: the asset’s original cost, its estimated useful life, and its estimated salvage value. Useful life refers to the period or number of units the asset is expected to be used. Salvage value is the estimated amount the company expects to recover from selling the asset at the end of its useful life. The depreciable cost is the asset’s original cost minus its salvage value.

Depreciation impacts a company’s financial statements by reducing the asset’s value on the balance sheet and creating an expense on the income statement. On the balance sheet, accumulated depreciation, a contra-asset account, reduces the asset’s carrying value. On the income statement, depreciation expense reduces net income, reflecting the cost of using the asset to generate revenue. Although depreciation is a non-cash expense, it impacts taxable income, potentially lowering a company’s tax liability.