An area I often see issues with during audits, or field questions from clients on, is accounting for fixed assets. Putting the necessary controls in place and applying consistency in treatment of fixed assets, can go a long way in wrapping up your financials monthly and at year end when preparing for your audit.
The first step towards accounting for fixed assets is gaining a proper understanding of what a fixed asset is. Fixed assets are tangible items purchased (such as buildings, land, equipment, etc.) and intended for long-term use (greater than a year) in an Organization’s operations. These are items generally are not easily, or intended to be, converted to cash within the immediate future. While the concept of a fixed asset is inherently easy to understand, Organizations should develop policies and procedures for how fixed assets will be accounted for. As best practice, these policies and procedures should be written in the form of a capitalization policy. Ideally, the capitalization policy will define what the Organization considers to be a fixed asset. Examples of items to consider in defining what the Organization considers to be a fixed asset should consist of the following:
1) Description of what a fixed asset is (see above).
2) Organization’s guideline for what it considers to be long-term use. As best practice, this should generally be items the Organization will use at least one year.
3) Materiality threshold for what an Organization considers being a fixed asset. This will vary based on the size of your Organization and the types of fixed assets you generally have in your operations. For example, a new electric drill will likely last a few years, but might only cost $300. Is this material enough to your Organization to capitalize and depreciate? On the other hand, a new industrial refrigerator for your office may very well cost over $1,000 and might be material enough to consider capitalizing.
4) How are units of property applied in consideration of a fixed asset? For example, you might order 10 laptops costing $6,000; however, each laptop’s individual cost is only $600. Would an individual laptop costing $600 be material enough to capitalize? Establishing an approach to treatment of units of property is absolutely key to ensuring consistency on your general ledger.
5) How will repairs and maintenance be treated? If a hail storm causes significant damages to your roof, should these items be classified as an expense? If an Organization chooses to capitalize the repairs, is a process in place to ensure the cost of your roof on your existing building is disposed of? Repairs and maintenance and treatment of these items can be confusing. While not accounting literature in and of itself, the Internal Revenue Service has guidelines for treatment of repairs and maintenance which may be useful in establishing your policy for treatment of repairs and maintenance expense.
6) For governmental entities, a written policy should be developed for fund financial purposes. For items that will eventually be capitalized on government-wide financials, it is best to account for these items in the capital outlay expense accounts on the fund financials. If this policy is not established, a great deal of time and effort will take place in preparation of and during the audit to account for capitalized assets. Alternatively, items should not be classified in capital outlay expense if the item will not end up meeting the capitalization criteria for the government-wide statements.
7) Useful lives and depreciation methods should be established. Organizations should consider how long they realistically expect their fixed assets to last and consistently apply this useful life. Depreciation methods may be accelerated; however, the general approach is straight line as that typically represents normal use of the fixed asset.
The next step is accounting for fixed assets is developing a method for tracking the fixed assets. If your Organization does not have accounting software to track fixed assets, you can utilize an excel spreadsheet which details the item description, purchase date, amount, funding source if purchased with federal funds, and general ledger account in which the item is recorded. Additionally, disposals of fixed assets should be tracked by noting the sales amount, date and item sold. Trade-ins should also be tracked on this same schedule. This information should be provided to your auditors during your audit.
The last step is developing an internal control process to ensure fixed assets are tracked. Ideally this will occur monthly. The schedule developed above should be reconciled to the general ledger. Additionally, review over operating expenses, such as supplies, repairs, maintenance and equipment, should be performed to ensure any larger expenses are not inappropriately classified. If only one individual is involved in your financial recordkeeping, another individual, such as an executive director or board member, could easily be placed into this review role. At least annually, an inventory of fixed assets should be performed. During this inventory, management may also consider if any fixed assets are impaired or should be junked.
These steps will go a long way in ensuring you are properly accounting for fixed assets. In addition to the guidelines above, some other items for consideration are the following:
- If construction is occurring and internal labor is utilized, these expenses should be allocated to the cost of construction and recorded as a fixed asset.
- If an Organization has long-term debt, interest expense should be considered for allocation to the cost of construction and recorded as a fixed asset.
- If you are an auditee, your CPA firm can provide you assistance in answering and tracking your fixed assets in terms of a depreciation system; however, it is your responsibility for determing whether an item needs to be capitalized and appropriately tracking these expenses.
We are always here to answer any questions related to accounting for fixed assets and can provide suggestions and helpful hints. As stated earlier and repeated throughout this article, establishment of policies and applying consistent accounting treatment will go a long way in ensuring the accuracy of your financials and can save much time and effort during your audit.