What Is Fixed Capital and What Does It Include?

Businesses rely on both short-term and long-term assets to operate efficiently. Fixed capital refers to long-term investments in physical assets essential for production that do not get consumed or converted into cash quickly. These assets support operations and generate revenue over time.

Understanding fixed capital is crucial for financial planning, investment decisions, and business stability. Without it, companies may struggle with productivity and expansion.

Key Characteristics

Fixed capital represents a long-term financial commitment. These assets are not intended for immediate sale or short-term liquidity. Unlike current assets, which fluctuate frequently, fixed capital remains on the balance sheet for years, allowing businesses to plan for growth and secure financing.

A defining feature of fixed capital is its role in supporting production without being directly consumed. For example, a manufacturing plant relies on specialized equipment to produce goods, but the machinery itself does not become part of the final product. This distinguishes fixed capital from working capital, which includes raw materials and inventory that are regularly used up or sold.

Acquiring fixed capital often requires large upfront investments, which can strain cash flow. Businesses frequently use long-term loans, leasing, or equity funding to finance these purchases. Secured loans, where the asset itself serves as collateral, help spread costs over time and preserve liquidity.

Asset Categories

Fixed capital consists of tangible assets that support operations over the long term. These assets are not intended for resale but instead contribute to production, service delivery, or infrastructure.

Land

Land is a fundamental fixed asset used for building facilities, operating farms, or storing inventory. Unlike other fixed assets, land does not depreciate because it has an indefinite useful life. However, improvements such as grading, drainage systems, or parking lots may be subject to depreciation.

From an accounting perspective, land is recorded at its purchase price, including costs such as legal fees, surveys, and site preparation. If a company buys land for $500,000 and incurs $20,000 in legal and closing costs, the total recorded value is $520,000. While land itself remains at historical cost, impairment—such as environmental contamination—may require a write-down under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).

Tax treatment depends on land use. In the U.S., businesses can deduct property taxes and maintenance costs, but the land itself is not eligible for depreciation. If sold, capital gains tax applies, with rates ranging from 15% to 20% for long-term holdings, depending on taxable income.

Machinery

Machinery includes equipment used in manufacturing, construction, and other industries that rely on mechanical processes. These assets often represent a significant portion of a company’s fixed capital investment. Examples include assembly line robots, printing presses, and industrial drills.

When recording machinery on the balance sheet, businesses include the purchase price and costs related to transportation, installation, and testing. If a company buys a machine for $100,000, pays $5,000 for shipping, and spends $10,000 on installation, the total capitalized cost is $115,000.

Financing options for machinery purchases include equipment loans and leasing arrangements. Under a capital lease, the asset is recorded on the balance sheet, while an operating lease may be treated as an expense under certain conditions. The Financial Accounting Standards Board (FASB) introduced ASC 842, requiring most leases to be recognized as liabilities, which affects financial ratios such as debt-to-equity and return on assets.

Buildings

Buildings house offices, factories, warehouses, and retail spaces. Unlike land, buildings depreciate over time due to wear and tear.

The cost of a building includes the purchase price and expenses such as architectural fees, permits, and renovations. If a company buys a warehouse for $2 million and spends $200,000 on structural improvements, the total capitalized cost is $2.2 million. Under U.S. tax law, commercial buildings are typically depreciated over 39 years using the straight-line method, resulting in an annual depreciation expense of approximately $56,410 ($2.2 million ÷ 39 years).

Ownership also comes with tax implications. Property taxes, maintenance costs, and insurance premiums are deductible business expenses. Businesses may qualify for tax incentives such as the Section 179 deduction, which allows immediate expensing of certain improvements like HVAC and security systems, up to a limit of $1.22 million in 2024.

Depreciation Methods

Fixed assets lose value over time due to wear, technological advancements, or obsolescence. Depreciation allows businesses to allocate the cost of these assets over their useful lives, affecting taxable income, cash flow, and financial ratios.

The straight-line method spreads the cost of an asset evenly across its useful life. If a company purchases a fleet vehicle for $50,000 with an estimated useful life of five years and a salvage value of $5,000, the annual depreciation expense is $9,000 [($50,000 – $5,000) ÷ 5]. This method is widely accepted under GAAP and IFRS.

For businesses looking to accelerate depreciation and reduce taxable income in the early years, the double-declining balance (DDB) method applies a depreciation rate twice the straight-line rate to the asset’s remaining book value. If the same vehicle were depreciated using DDB, the first year’s depreciation would be $20,000 [(1 ÷ 5) × 2 × $50,000], significantly reducing taxable income in the initial period. This method benefits industries where assets quickly become outdated.

Under U.S. tax law, the Modified Accelerated Cost Recovery System (MACRS) assigns fixed recovery periods based on asset classifications. Office equipment such as computers and printers typically fall under a five-year recovery period, while commercial real estate follows a 39-year schedule. MACRS includes both 200% and 150% declining balance methods before switching to straight-line depreciation when it becomes more advantageous. This system helps businesses maximize deductions in the early years, improving cash flow.

Some companies use units of production depreciation, which ties expense recognition directly to usage rather than time. This method is useful for industries where asset wear depends on production volume. If a factory machine is expected to produce 100,000 units over its lifetime and costs $100,000, the depreciation expense is $1 per unit produced. If the machine generates 20,000 units in the first year, the depreciation expense for that period is $20,000. This approach ensures costs align with revenue generation.

Balance Sheet Presentation

Fixed capital appears on the balance sheet under non-current assets, reflecting its long-term nature. Businesses categorize these assets based on liquidity and usage, typically listing them in order of permanence. Unlike current assets, which convert into cash within a year, fixed capital remains in service for extended periods, influencing financial ratios like return on assets (ROA) and asset turnover.

Fixed capital is recorded at historical cost, adjusted for depreciation, impairment, or revaluation under applicable accounting standards. Under IFRS, companies can use the revaluation model, periodically adjusting asset values to fair market price, while GAAP generally mandates the cost model, where assets remain at book value unless impaired. Companies using revaluation may show higher asset values, affecting leverage ratios like debt-to-equity.

Liabilities associated with fixed capital, such as long-term loans or bonds used to acquire these assets, appear under non-current liabilities. The relationship between these liabilities and fixed capital is crucial for understanding financial leverage. A high fixed asset turnover ratio may indicate efficient asset utilization, while excessive capital expenditures relative to revenue could suggest overinvestment.