Fixed assets: a simplified guide.

In the business world, there are many concepts that may seem complicated at first glance, but understanding them is essential for anyone who wants to understand how companies and organizations operate. Among these concepts, fixed assets stand out as an essential element in the construction of any economic entity. So what are these assets? And why is it important? And how is it treated accounting? This article will take you on a simple journey to explore the world of fixed assets, providing you with everything you need to know in an easy and understandable way.

What are fixed assets?
Imagine that you own a factory to produce furniture. This factory needs a building, machines for cutting and forming wood, trucks for transporting products, and offices for employees. All these things that the company owns and uses in its day-to-day operations, which are expected to continue to serve for many years, are what we call fixed assets.

More precisely, fixed assets are tangible assets, that is, they have a physical presence that can be seen and touched, and long-term, that is, their life span exceeds one financial year. These assets are not purchased with the aim of selling them quickly to make a profit, but are acquired to be used to generate revenue and support the company's long-term operations. For this reason, they are also known as non-current assets, and they form a vital part of the infrastructure of any business.

Examples of fixed assets
For a deeper understanding, let's review some common examples of fixed assets:

  • Buildings and lands: such as factories, administrative offices, warehouses, and the lands on which these facilities are built. These are the foundation on which businesses are built.

  • Machinery and equipment: includes all machines used in production, manufacturing equipment, technical devices such as computers and servers, and even small tools that are used in daily operations.

  • Furniture and equipment: Everything related to furnishing offices and buildings, such as offices, chairs, cabinets, lighting and air conditioning systems.

  • Means of transportation: cars, trucks, buses, or any other vehicles used by the Company for transportation purposes, whether for the transport of goods or employees.

  • Capital improvements: Significant renovations or additions to existing assets to increase their value or useful life, such as a complete renovation of a building or the addition of a new division to a factory.

Characteristics of fixed assets
Fixed assets have several characteristics that distinguish them from other assets:

  • Long-term: As mentioned, its useful life spans many years, which means that it contributes to profits over a long period.

  • Tangible: Can be seen and touched, unlike intangible assets such as patents, intellectual property rights, or goodwill.

  • Not intended for sale: The primary purpose of buying them is to use them in the company's operations, not to resell them for a quick profit.

  • Depreciation: With the exception of land, most fixed assets lose part of their value over time as a result of use, obsolescence, or damage. This impairment is known as depreciation, and is accounted for to distribute the cost of an asset over its useful life.

The importance of fixed assets for companies
The importance of fixed assets is not limited to being just the property of the company, but goes beyond that to include vital aspects of business success and continuity:

  • Revenue generation: These are the basic tools that enable a company to produce goods or provide services. Without machinery and buildings, the factory cannot produce, and therefore cannot generate revenue.

  • Enhancing competitiveness: Having modern and efficient fixed assets can give a company a significant competitive advantage. For example, sophisticated production machines can increase product quality, reduce production costs, or increase the speed of work, making the company more competitive in the market.

  • Supporting growth and expansion: Fixed assets provide the necessary infrastructure for the company's future growth and expansion. If a company wants to increase its production capacity or enter new markets, it will need additional investments in fixed assets.

  • Improved Financial Position: Fixed assets are recorded on the company's balance sheet as part of its assets, enhancing its total value and reflecting the strength of its financial position in front of investors and creditors.

How to calculate depreciation of fixed assets Depreciation
As mentioned, fixed assets lose their value over time, and this process is called depreciation or depreciation. Accountingly, the cost of an asset is distributed over its estimated useful life. The goal is to match the cost of using the asset with the revenue it generates during its use period. There are several ways to calculate depreciation, the most famous of which are:

First: Straight-Line Method

This method is the simplest and most common. In them, the cost of the asset is evenly distributed over its useful life. To calculate the annual depreciation premium, we use the following formula:

Annual Depreciation Premium = Original Cost of Asset – Scrapping Value / Estimated Useful Life

  • Original cost: The amount paid by the company to purchase the asset.

  • Scrap value: The expected value of an asset at the end of its useful life, i.e. the amount at which the asset can be sold as scrap or residual value.

  • Estimated useful life: The number of years an asset is expected to serve the company.

Illustrative example: 
If a machine company buys at a cost of 30,000 riyals, and its useful life is estimated at 5 years, and its scrapping value is  3,000 riyals, the annual depreciation premium is calculated as follows: annual 
depreciation premium = 30,000 – 3,000 / 5 = 27,000 / 5 = 5,400 riyals.
This means that the company will record a depreciation expense of 5,400 riyals every year for 5 years.

Benefits of the straight-line method:

  • Ease and simplicity: Easy to understand and apply, making it a favorite for many businesses.

  • Accurate forecasts: Provides a stable and stable forecast of annual depreciation costs.

Second:  Double Declining Balance Method

This method is a little more complicated and is usually used for assets that lose a significant part of their value in the early years of their life. In this method, a higher depreciation rate is calculated in the early years, and this percentage gradually decreases over time.

How to calculate: The 
book value of the asset is multiplied by the original cost minus the accumulated depreciation by a fixed depreciation ratio that is twice the depreciation percentage by the straight-line method.

Illustrative example:

If the depreciation ratio is 20% 100% / 5 years, the depreciation percentage by the declining multiplier method will be 40% 20% × 2.
If the asset value is SAR 30,000:

  • First year: Depreciation premium = 30,000 × 40% = 12,000 riyals.

  • Second year: Residual book value = 30,000 - 12,000 = 18,000 riyals.

    Depreciation premium = 18,000 × 40% = 7,200 SAR.
Thus the process continues until the end of the useful life of the asset.
Benefits of the decreasing double installment method:

  • Reflect realism: better reflect the depreciation of assets that are quickly depreciated in the early years.

  • More realistic cost allocation: Helps distribute costs more realistically over the life of an asset, supporting financial planning and accounting analysis.

Difference between current assets and fixed assets

It is very important to distinguish between fixed assets and current assets, as both are part of the company's assets, but they differ in nature and purpose:

  • Fixed assets: As mentioned, they are long-term, tangible, non-fast-selling assets that have been used in operations for more than a year.

  • Current assets: These are assets that can be converted into cash easily and quickly, usually within one year. Examples include cash in the bank, inventory of ready-to-sell products, and receivables amounts owed to the company from customers.

The fundamental difference lies in the liquidity of how easy it is to convert the asset into cash and the purpose of holding the asset. Current assets provide liquidity to meet the day-to-day needs of the company, while fixed assets provide the infrastructure for long-term operations.

 

Common mistakes in fixed asset management

Managing fixed assets is not easy, and there are some common mistakes that companies may make:

  • Accounting errors: such as incorrect recording of the value of the asset, or failure to calculate depreciation correctly, which affects the accuracy of the company's financial statements.

  • Lack of good tracking: Lack of an effective system to track fixed assets, their locations, and status, which may lead to asset loss or not being optimally utilized.

  • Neglect of maintenance: Failure to perform periodic maintenance of assets leads to rapid deterioration and reduced useful life, which increases repair or replacement costs.

  • Lack of planning for replacement: Lack of a clear plan to replace old or dilapidated assets, which may affect the efficiency of production processes.

To avoid these mistakes, companies should invest in asset management systems, train teams on accounting and management best practices, and develop clear maintenance and replacement plans.

Fixed assets are the backbone of any business. Understanding their nature, characteristics, importance, and how they are managed accounting is critical not only to accountants and financial managers, but to anyone who wants to understand how companies operate. With good fixed asset management, companies can make the most of them, enhance their competitiveness, and support their long-term growth and sustainability. It's not just a property, it's vital investments that contribute to building a bright business future.