Fixed Assets are business purchases which will be used by the business for a few years. Examples are machinery, vans and computers.
To be classified as a Fixed Asset, rather than an Expense, the purchase would tend to have significant value. For a small business, £500 is a suggested minimum, and different businesses will have different ‘capitalisation’ policies.
Fixed Assets are classified as Assets in the Balance Sheet, not Expenses in the Profit and Loss Account.
Fixed Assets fall into two categories:
• Tangible Fixed Assets (eg. Cars, Machinery, Computers, Buildings, Desks)
• Intangible Fixed Assets (eg. Goodwill, Intellectual Property)
Tangible Fixed Assets
The main point about the purchase of a Fixed Asset is that the business will probably own it for some time, in other words, it is not an Expense.
Tangible Fixed Assets are normally grouped into categories, especially for Balance Sheet reporting.
The main categories of Tangible Fixed Assets are:
• Furniture and Fittings
• Motor Vehicles
• Plant & Machinery
Most Fixed Assets gradually lose value because they have a limited useful life – they ‘depreciate’, which means that they lose their value. So they have to be depreciatedin the Year End Accounts.
Fixed Assets depreciate at different rates, which is one of the main reasons for grouping similar assets together.
Capitalisation is the decision and process of recording a purchase as a Fixed Asset in the business records.
A capitalisation policy will include deciding the the minimum value for capitalising an asset, and the expected useful life of each Fixed Asset.
For example, a purchased car will be capitalised because it is expensive and will last several years.
A computer which may cost £400, might be capitalised because the business owner might think it to be a good idea to keep a proper record of it in the Fixed Asset Register.
On the other hand, a business might buy a vacuum cleaner for £200, which will probably last several years, but would usually be classed as an Expense because the value is too low to capitalise as Fixed Asset.
Depreciation is the gradual transfer of the original cost of a Fixed Asset from the Balance Sheet to the Profit and Loss Account. The transfer is usually done by a Journal.
It could be said that Depreciation is “Expensing” a Fixed Asset – ie. a percentage of the cost of the Fixed Asset becomes an Expense, and the Fixed Asset then has a lower value on the Balance Sheet. It is usually a simple calculation which is usually made once a year by very small businesses.
Depreciation and Tax
For small businesses, the depreciation policy does not affect tax.
HMRC ignores depreciation when calculating tax, because they have a different system for setting off Fixed Assets costs against tax – called Capital Allowances – see below.
Straight Line Depreciation
For example, a computer costs £1,000, and is expected to last 4 years, ie. an annual depreciation rate of 25%. On a straight line method the annual depreciation is £250, which is transferred to the Profit and Loss Account from the Balance Sheet every year for 4 years. So after 1 year, the Balance Sheet value becomes £750, and the £250 has been charged as Depreciation to Profit and Loss. In the second year, the computer depreciates to £500, and another £250 is charged to Profit & Loss.
Reducing Balance Depreciation
Another depreciation method is the reducing balance method. This method may be suitable when the Fixed Asset will be gradually losing its value, but its useful life cannot be precisely estimated. For example a van may cost £8,000. In the first year 25%, ie £2,000 could be depreciated, leaving a balance of £6,000. In year 2, 25% is depreciated from the reduced balance of £6,000, ie. £1,500, leaving a balance of £4,500, and so on.
Fixed Asset Register
A Fixed Asset Register is the record of a business’s Fixed Assets. The basic record includes the original cost, date purchased and supplier’s name. Then the depreciation each year is recorded, giving a Net Book Value for each Fixed Asset.
Some businesses will also record where a Fixed Asset is located, maintenance schedules, etc.
Specialist software is available for a Fixed Asset Register, but for most small businesses a spreadsheet will be fine.
We maintain basic Fixed Asset Registers for all our clients.
This may be a surprise and puzzling at first reading – HMRC does not allow Depreciation as an Expense deduction in the calculation of business taxes.
There are two good reasons (at least) for this:
• It would be possible for a business to manipulate its business tax by setting its Capitalisation and Depreciation Policy in a certain way.
• Some Fixed Assets are very expensive and a high financial burden for small businesses. Therefore, in some circumstances the government allow the full cost as a deduction against tax in the first year.
These special allowances, eg. First Year Allowance (FYA) and Annual Investment Allowance (AIA) change from year to year.
HMRC has its own version of depreciation called “Capital Allowances”, which are the Expense deductions, which treat all businesses the same. Some Capital Allowance calculations are easy – others are quite complex. We recommend that you always get the appropriate tax advice.