Net Fixed AssetsDefined along with Formula & How to Calculate
What are Net Fixed Assets?
- The management may compute the asset’s accumulated depreciation to know how long the fixed assets have been serving their purpose. Just by looking at the total depreciation amount, the user of financial statements will know when the assets were bought. The total accumulated depreciation amount may provide management with the relevant information as to when is the right time to replace or invest in a new fixed asset.
- Net Fixed Asset computation is helpful, especially in the merger or acquisition of a company. It is notable that before acquiring or merging with one company, its overall business operations must be duly accounted for, like its Assets, Liabilities, and the components of its Shareholder’s Equity.
- When the value of the Total Fixed Assets is comparably higher as compared to the Net Fixed Assets, an indication that a larger sum of money will be needed at the time an asset replacement will be required in the future. This is an important valuation criterion for acquiring companies.
Net Fixed Asset Formula
The formula to arrive at the Net fixed Asset amount is:
Net Fixed Assets = Gross Fixed Assets – Accumulated Depreciation
The deductions from the asset’s purchase price are Accumulated depreciation and any impairments applicable.
Examples of fixed assets include tangible assets with a long-term useful life like Land, Buildings, Machinery, Production Equipment, etc.
Accumulated Depreciation is the amount of the total recognized depreciation expense relating to the used-up portion of an asset.
Such an account is a line item in the Profit and Loss Statement.
Analysts think that fixed asset accounting is more accurate if they recognize other deductions like fixed asset liabilities from the original purchase price and improvement cost.
Below is an expanded version of the Net Fixed Asset Formula:
Net Fixed Asset = (Total Fixed Asset Purchase Price + Capital Improvements) – (Accumulated Depreciation + Fixed Asset Liabilities)
Removing liabilities that arise from fixed assets provides a more accurate net fixed asset value.
Components of Net Fixed Assets
These are non-current assets mostly used in the company’s production or general business operations.
Fixed assets are not sold in the ordinary course of business and are not easily convertible into cash.
The two common types of fixed assets are:
Tangible Asset – can be physically touched like machinery and equipment, real estate assets such as land or buildings, furniture, fixtures, etc.
Intangible Asset – only exist through stipulation and cannot be seen and touched.
The best examples are goodwill, trademark, copyright, patent, etc.
Accumulated depreciation is the expense related to the reduction of the value of fixed assets from the date of purchase up to its current accounting period.
Every company must follow the yearly recording of depreciation expenses.
For Example, a company purchased new equipment amounting to $500,000 in January 2019, with ten years of useful life and a $10,000 salvage value.
Assume the company follows the calendar period of accounting.
The annual depreciation for the equipment is therefore $49,000 ($500,000 – $10,000) / 10 years)
The Accumulated Depreciation of the asset until Dec. 2021 is then $147,000 ($49,000 x 3 years)
Companies seek ways to increase production efficiency, increase space capacity, etc. so that the existing equipment or machinery can function more efficiently and effectively.
The computation of such capital improvement will be the capital improvement cost over its declared useful life.
Fixed Asset Liabilities
These are debts related to the acquisition or improvements made to the asset which a company is required to pay lenders.
Net Fixed Assets Formula Example
PBI Automobile is planning to acquire AVG Automobile.
Before the acquisition, PBI company wants to verify the financial status of AVG, and one of the primary criteria for PBI company to acquire AVG is the good financial standing of its Assets.
The relevant data provided are as follows:
- Sum of all fixed assets: $17,000,000
- Accumulated depreciation: $500,000
- Capital Improvements: $3,500,000
- Total liabilities on fixed assets: $220,000
To compute for Net Fixed Assets:
Net Fixed Assets = ($17,000,000 + $3,500,000) – ($500,000 + 220,000)
Net Fixed Assets = $19,780,000
Net Fixed Assets Ratio = Net Fixed Assets / (Fixed Assets + Capital Improvements)
Net Fixed Assets Ratio = $19,780,000 / ($17,000,000 + $3,500,000)
Advantages & Disadvantages of Net Fixed Assets
- Provides useful financial information that end users may use in their decision-making process, and also gives insight into the overall financial health of the company.
- The method of computation must be known to the analyst because there are a lot of methods for the recognition and recording of assets, depreciations, or asset disposals.
- In capital-intensive industries, the key determiner of when or how much is needed to invest is in the fixed asset analysis. This type of industry invests more in fixed assets and expects future benefits, which means that when the company is growing, it is understandable if the company will face negative cash flows from the purchases of fixed assets.
- Net fixed asset calculation will be of no use if the recognition principle used for depreciation is accelerated depreciation. It is a method of recognizing the full depreciation of an asset in the same year of purchase. With this method, the ending net book value will be zero, which will result in a wrong interpretation of the asset’s net book value.
- If the asset is fully depreciated, it does not mean that it is of no value. There are cases where after the life expectancy of the assets, they still are useful for many more years.
- It must be noted that the value of the asset per book differs from its value per tax consideration. The company may benefit if the accelerated depreciation method is used but the said method is not GAAP accepted.
Knowing the actual value of the assets of the company is essential especially when it comes to its valuation.
Knowing this can help management make important financial decisions. Not knowing will prove to be very costly in the long run.
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