Tangible Assets
Tangible assets are long-lived assets which have physical existence. They are also referred to as property, plant and equipment (PPE). They are capitalized on balance sheet and depreciated over their useful lives.
For an asset to be classified as a tangible asset, it must meet the following conditions:
- It must be tangible, i.e. it must have physical existence,
- It must be non-current, i.e. it must generate economic benefits over a period of more than one year or more than one operating cycle, and
- It must be operating in nature, i.e. it must be expected to be used in the main operations of the business.
Tangible assets can also be referred to as non-current operating assets and expenditure incurred on purchasing or constructing them is called capital expenditure. Typical examples of tangible assets include land, land improvements, buildings, machinery, office equipment, furniture and fixtures, etc.
Buildings are intangible assets because (a) they have physical existence, (b) they have a useful life longer than one year, say 15 years, and (c) they are operating in nature. Copyrights, on the other hand, are not tangible assets but are intangible assets because even though they are operating in nature and they have useful life longer than one year, they do not have physical existence. Long-term investments are not tangible assets because even though they are non-current they do not have any physical existence, and/or they are not operating in nature.
Accounting for Tangible Assets: Cost Components
Amount expended on acquiring or constructing tangible assets is recorded as an asset on balance sheet which is periodically charged to income statement. The process through which the cost of a tangible asset is written off over its useful life is called depreciation. Popular depreciation methods include straight-line method, declining balance method, modified accelerated cost recovery system (MACRS) method, etc. ' Depreciation is recorded by debiting the depreciation and crediting the accumulated depreciation account, which is a contra-account to the cost account. The carrying value of a tangible asset equals the difference between cost and the closing balance of the accumulated depreciation.
Some tangible assets such as land have unlimited useful life and hence they are not depreciated. However, all assets are tested for impairment when there are indications that their carrying value might be higher than their fair value (recoverable value in case of IFRS).
The amount at which the asset is recognized includes all such costs which are necessary to bring the asset to its intended use. Typical costs which form part of the cost of a tangible asset include invoice amount, any irrecoverable taxes, transportation costs, insurance in transit, installation costs, testing costs (minus any proceeds from test run production), etc.
Cost of Land
Land is a tangible asset with unlimited useful life, hence it is not depreciated but is tested for impairment.
Cost of land includes:
- Purchase price
- Transaction costs such as commissions, legal fees, etc.
- Cost of removal of existing structures
- Amounts paid to third parties such as government in relation to the development of the area such as construction of roads, development of electricity, gas, water, sewerage systems, etc. only if the third party or the government is responsible for maintenance of such systems.
Cost of land doesn’t include costs incurred in development of internal infrastructure such as fences, pavements, etc. whose maintenance is responsibility of the land-owner.
Land Improvements
Land improvements represent items which improve the usability of land such as landscaping, pavements, fencing, etc. Cost of land improvements include costs incurred on items whose maintenance is responsibility of the land-owner.
Because land improvements must be maintained by the land-owner, they must be redone after a period of time and hence they have limited useful life, hence they are depreciated.
Buildings
Buildings are structures erected on land. Unlike land, they are depreciable and when land and buildings are acquired together, the basket purchase cost must be allocated to land and building based on their fair values.
Cost of acquired building include purchase price, transaction fees such as commissions, legal fees, etc. plus any costs incurred on adjustments and alterations necessary to put the building to its intended use.
Cost of self-constructed buildings include:
- Cost incurred to obtain the necessary approval to commence construction such as municipal fees, regulatory clearance fees, etc.
- Costs incurred on designing the building i.e. architect’s fee, consultant’s fee, etc.
- Cost incurred on construction including materials, labor and overheads.
- Capitalized interest
Equipment, Machinery, etc.
Cost of equipment, machinery, furniture, etc. include purchase price, irrecoverable taxes, transaction costs, transportation costs, insurance in transit, installation and testing costs, etc.
by Obaidullah Jan, ACA, CFA and last modified on