Effective fixed asset management is crucial to preventing ghost assets from accumulating dust and debt and maintaining accuracy in financial reporting to keep costs at bay. Equally important when it comes to property, facilities, equipment and other fixed assets is ensuring they are effectively maintained and used by employees.

While inventory accounting software can help organizations manage costs associated with owning these items, it’s essential that internal accountants and finance professionals, as well as equipment managers and directors, are all on the same page to mitigate risks and boost efficiency.

Factoring setup into the equation

Companies in the construction and manufacturing industries tend to employ many workers on an hourly basis. While giving employees the right resources to do their jobs correctly can boost efficiency, many managers may overlook the time it actually takes to set up these tools – or machines, vehicles and other fixed assets.

As many organizations look to cut costs throughout processes, decision-makers shouldn’t oversee the behind-the-scenes work. This includes filling up vehicle engine tanks, turning on equipment, powering up and testing machines and inspecting all items throughout operations to ensure workers can carry out their tasks safely.

While it may only take a minute or two for an office worker to turn on his or her computer every morning, turning on machines and preparing equipment for use can take a significant amount of time. If equipment managers aren’t vigilantly monitoring the setup process, the company risks wasting valuable time getting the workplace ready. There are several costs associated with a delayed setup. For one, the time it takes workers to prepare their workstation is billable. Business Management Daily explains the Department of Labor has recently begun focusing on whether employers are accurately compensating employees for the time it takes for computers to load and machines to warm up.

Meanwhile, if workers aren’t setting up correctly, they may not be preparing equipment effectively enough to produce the best output. Decreased productivity results in lost revenue.

To prevent the costs associated with a slow startup, it’s essential for equipment managers and financial departments to work together to seek out the best ways to kick off the workday without jeopardizing productivity or safety

Of course, managers aren’t the only ones concerned with boosting equipment use efficiency. It’s always important to ensure staff at all levels understand the reasoning behind established processes and are informed of operational changes.

Depreciation refers to how the costs of owning and maintaining fixed assets evolve over time. Equipment, vehicles, facilities, electronics, furniture and other tangible items owned by businesses wear out over time and eventually become obsolete. Because property depreciation can serve as a tax deduction for corporations and small-business owners alike, it’s essential for company leaders  to rely on the right tools to ensure accurate property accounting.

Fixed asset management software can help firms of all sizes effectively track the book value of items to ensure organizations are compliant and acquiring the tax breaks they’re entitled to. While solutions providers can work with companies to achieve this, it’s a good idea for internal accountants, CFOs, equipment managers and other stakeholders to understand common standards for calculating and reporting depreciation. 

Calculating Fixed Asset Depreciation Under GAAP

To expense assets and file for tax returns, companies of all sizes rely on the guidelines set fourth by generally accepted accounting principles, or GAAP. Under these standards, depreciation is calculated based on four factors, the American Institute of Professional Bookkeepers stated in “Mastering Depreciation.” These determinants include the asset’s cost, lifecycle, residual value, and the depreciation method the company relies on. The AIPB goes on to explain each of these factors in depth.

1. The cost of the asset

As previously mentioned, the total cost of an asset isn’t just the amount the business paid to buy the item. It also includes any expenses the company makes to acquire, transport and set up the asset for use. This means the asset’s costs includes sales taxes imposed on the item, transportation or freight costs and the amount paid to professionals who install the item.

2. The asset’s estimated lifecycle

The life of an item refers to the amount of time the company forecasts the asset will be in use. The AIPB explains lifecycles can also be determined by the amount of product a piece of equipment will create, the number of miles it drives and other estimates.

3. The asset’s residual value

The residual, or scrap, value of an item refers to the amount of money a company can salvage from an asset after it’s disposal – either sale or trade in. The residual value does not depreciate. Rather, it is subtracted from the item’s acquisition cost to determine the depreciable base. 

4. The depreciation method

There are several main methods companies rely on to determine how items depreciate. The straight-line, or SL, method involves dividing the depreciable base by the estimated lifecycle, in number of years. The units of production (UOP), or units of output method is used year-to-year and factors in units of production, miles driven or other measures. Finally, the accelerated methods include the declining balance and sum-of-the-years’-digits models.

Fixed assets are a major expense for companies in all industries, and especially so for those in manufacturing. One of the best ways to maintain efficiency, gain a return on investments made in equipment and tools, and minimize unnecessary spending is to accurately track items’ depreciation. 

Depreciation refers to the change in a fixed asset’s value over time or based on use. The value of nearly everything owned by a company depreciates, including machinery, computers, vehicles and furniture. While land doesn’t necessarily lose value, buildings and fixtures placed on property depreciate.

When organizations collect information to compose financial statements, there are several key elements that factor into the equation. They are the asset’s cost, estimated lifecycle, residual value and the method of depreciation decision-makers choose to rely on, the American Institute of Professional Bookkeepers explains. Read more about fixed asset management in this eBook.

Under the generally accepted accounting principles, there are four basic methods U.S. businesses use to determine an asset’s depreciation expense.

1. The straight line method

This system is the most common among companies in the U.S., Houston Chronicle’s Small Business states. The SL method involves the acquisition cost, which includes all expenses the company paid when purchasing, transporting and setting up an asset; and the residual value, which is the amount that can be salvaged from an item once it’s reached the end of its lifecycle, when the organization sells it or trades it in for a replacement or new version. Subtracting an asset’s residual base from the acquisition costs provides the item’s depreciable base.

Using the SL method, fixed asset professionals then divide the depreciable base by the number of years in the item’s lifecycle. The AIPB explains the depreciation expense is therefore the same each year or filing period.

While this method is reliable, it does not take into account unique circumstances that may impact an item’s use.

2. The units of production method

This method is similar to the SL calculation. Using the UOP method, companies divide the asset’s residual value by the units created, miles driven or other production measurements. Therefore, a machine’s depreciated value may fluctuate between reporting periods, leading financial statements to vary at least slightly each time.

3. The sum of the years’ digits method

The last two methods are considered accelerated methods. Using the SYD system, organizations allocate a higher depreciation value on items during the first years of ownership, as the number of years remaining in the asset’s lifecycle is divided by the sum of each digit in its life and then multiplied by its residual value to calculate the depreciation expense, Chronicle explains.

4. The declining balance method

The DB method is based on the asset’s book value. Companies subtract the item’s accumulated depreciation from the asset’s total initial cost.

For everything you need to know about fixed asset management, check out this new eBook.

No matter how thorough managers may be when manually tracking and calculating fixed assets inventory accounting data and composing the company’s balance sheet, the chances of error throughout the professionals’ processes are too great to put the organization’s finances and reputation at risk.

While many may perceive fixed asset inventory management services and solutions as a tool only available to and beneficial for large corporations, the software options on the market today vary immensely to suit the needs of organizations of all types and sizes. By partnering with the right provider, businesses have access to customizable technology and the right support to meet their entity’s individual needs.

Fixed asset inventory management errors have major consequences

Investing in software is the first step toward improved fixed asset inventory accounting, but just implementing the technology is not enough. As businesses expand and evolve, their needs may no longer be met by solutions catering to smaller endeavors. It’s a good idea to choose a service provider that can work with the organization continuously and provide flexible solutions that can be altered, adjusted and even completely overhauled to keep up with the business’ growth and federal regulatory changes.

If organizations aren’t using the right tools to effectively manage their inventory of fixed assets, they risk over- or under-ordering, wasting time in the stockroom, misstating information on financial reports, paying too much on tax and insurance fees, and not putting equipment to the best use possible.

Accounting Tools, which provides online educational accounting courses, outlines inventory errors that apply to both moving and fixed asset invnetories which can lead to these negative consequences.

Incorrectly counting units: Inventory managers and employees miscount or miscalculate the number of items owned by an organization. This simple error can have major consequences, such as valuation errors in every associated financial report.

Relying on the wrong measurement unit: By not using software, managers risk collecting data incorrectly when they accidentally utilize an inappropriate unit of measurement. While individual item quantities may be accurate, the item groupings may be way off, leading to substantial errors down the line.

Tracking an incorrect book value: Without the right software, businesses risk seeing unused stock build up. The value of fixed assets inevitably experiences depreciation. If managers aren’t accurately tracking the items’ changing value, the inventory risks being associated with an incorrect cost.

Incorrectly assigning asset relationships: If managers don’t have a central, accurate system to rely on to determine parent-child relationships between items, they risk assigning incorrect part numbers to fixed assets, which can result in overstocking inventory or having too many or too few equipment components.

1.  The bonus depreciation election is an election not to claim it.

While most tax elections allow you to do something (such as claim Section 179 expense or use the MACRS Alternative Depreciation System <ADS>), the bonus depreciation election is an election not to claim it. This is because claiming the deduction for bonus depreciation is not optional; if you place qualifying property in service in a year in which bonus depreciation is allowed, the deduction is mandatory unless an election not to claim it is made.

To make the election not to claim bonus depreciation, attach a statement to a timely filed tax return (including extensions) for the year in which the deduction applies. The election is made either for all property qualifying for bonus depreciation or for one or more specified classes of assets. (For example, you can elect not to claim bonus depreciation for all seven-year property.) The election is an annual election and only applies to property placed in service during the year for which the election is made. For a consolidated group of corporations, the election is made for each member of the group by the parent corporation. The election cannot be revoked without the IRS consent.

The election should state that the company does not want to claim bonus depreciation under IRS Code Section 168(k) either for all qualifying property placed in service during the year or for property in whichever classes you specify. The ending date of the applicable tax year for which you want the election to apply should also be stated.

If you do not want to claim bonus depreciation, it is essential to attach the required statement to the tax return. If you do not claim the deduction and do not make the formal election to that effect, the property will nonetheless be treated as if you had claimed it. When this occurs, the property will never be fully depreciated because before calculating depreciation each year, you must reduce its basis first by the amount of bonus depreciation you did not claim!

Finally, remember that when you claim bonus depreciation on an asset, the deduction is also allowed for Alternative Minimum Tax (AMT) purposes. In fact, any property on which bonus depreciation is claimed is exempt from the AMT depreciation adjustment as the same depreciation as claimed for regular tax purposes is also allowed for AMT purposes.  Therefore, if an election is made to forgo the bonus depreciation deduction, such property may be subject to the AMT depreciation adjustment.

2.  The date you acquire an asset is not always the date on which depreciation begins.

It’s true: the date you acquire an asset is not necessarily the day on which you can begin depreciating the asset. In order to depreciate any asset, it must first be placed in service.

Although generally it may seem obvious when an asset is placed in service, this is not always the case. To be considered “placed in service,” an asset must be installed, operational, and available for use. So, for example, if rental property is ready to be rented, an actual lease agreement is not necessary to begin depreciating the asset. Once such property is available and ready for rental, depreciation on it can begin. Another example is if an elevator is installed in a new building, it cannot be depreciated before the building itself is placed in service.

To be considered “operational,” an asset must be ready to be operated for the intended purpose for which it was acquired. For example, if a business acquires a forklift for heavy lifting but it must be modified before it can be used to lift a certain desired weight, depreciation cannot begin on it before it is fully able to be used for its intended purpose.

3.  Section 179 expense is included as “depreciation” when determining the maximum amount that may be claimed on a luxury vehicle.

We know there are limitations on the amount of depreciation allowed on any luxury vehicle, based on when it is placed in service. You may think that a way to avoid having the limits apply is to claim Section 179 expense on the vehicle. However, if you think this is so, you would be mistaken. “Depreciation” in this case includes any Section 179 expense. Therefore, it would serve no purpose (and, in fact, would put you at a disadvantage as you would be wasting a potential deduction) to claim Section 179 expense on a luxury vehicle.

 4.  While the midquarter averaging convention usually gives you less depreciation than the half-year convention, any property placed in service in the first half of the year will have more depreciation calculated for it than it otherwise would.

Averaging conventions are the rules for prorating depreciation on assets in the year in which they are placed in service and, also, when disposed (if disposed of before the end of their depreciable lives). For tax reporting purposes, which averaging convention you use is mandated by the IRS and generally is based on the type of property. However, whenever more than 40% of the total depreciable basis of qualifying property is placed in service during the last three months of a tax year, the midquarter averaging convention must be used for all property for which the half-year convention would otherwise be used. The midquarter convention applies to all depreciable property except for nonresidential real and residential rental property (and property both placed in service and disposed of in the same tax year).

The midquarter averaging convention was designed to close a tax loophole where a business could place costly assets in service at the end of a tax year and still receive six months of depreciation on them by using the half-year convention. Now, when such a scenario occurs and the midquarter convention must be used, it usually results in less depreciation being claimed. However, this may not be the case for all property.

Consider this: when using the half year convention, property is allowed six months worth of depreciation regardless of when it is placed in service during the year. On the other hand, with the midquarter convention, property is deemed placed in service at the midpoint of the quarter in which it is placed in service. Therefore, an asset placed in service during the first quarter of a 12-month year, receives one and a half months of depreciation for its placed-in-service quarter plus nine months of depreciation for the rest of the year, giving it ten and a half months of depreciation in total. (Even if placed in service in the second quarter of the year, it would receive seven and a half months of depreciation.) This is a much larger amount than had it used the half-year averaging convention, which would have given the asset only six months of depreciation!

Understanding that the midquarter convention can work to your advantage by maximizing your depreciation deductions at certain times can present you with an opportunity for doing some tax planning. Consider the scenario where most of a company’s newly acquired assets are placed in service in the first six months of the year while close to 40% are placed in service at the end of the year. If this were the case, a small additional purchase of a fixed asset(s) could result in more than 40% of qualifying property being placed in service during the last three months of the year and the midquarter averaging convention would then apply. Therefore, with proper planning you could easily increase the company’s total depreciation expense claimed for the year. Of course, since the midquarter convention is not elective, this only works under limited circumstances.

 5.  If you acquire a covenant-not-to-compete when purchasing a business, it has a 15-year amortizable life for tax purposes regardless of the actual duration of the contract.

Before IRS Code Section 197 was enacted, most intangible assets were amortized over their determinable useful lives. However, the IRS often disagreed with the lives assigned by taxpayers and frequently ended up going to court over it. Add to this the difficulties taxpayers often encountered when trying to prove that the limited useful life chosen was correct and you can see why something needed to be done. The principal goal of Section 197 was to rid the court dockets of a significant amount of litigation and finally end much of the uncertainty that surrounded the determination of amortizable lives.

Section 197 mandates a 15-year life for certain intangible assets, many of which are acquired when purchasing a trade or business. When Code Section 197 was first introduced, many taxpayers were unhappy to learn that covenants-not-to-compete were included in the mandatory 15-year recovery period. Most covenants-not-to-compete have a much shorter life than 15 years. However, Congress believed that if taxpayers were allowed to write off a covenant-not-to-compete over its actual, but shorter, life, it would provide too great a temptation to overstate the value of the covenant while understating the value of the rest of the acquired assets of the business.

And there you have it; your five fun facts about fixed asset management! Now share your fun facts or send these to a friend.