Fixed assets are ordinarily presented in the balance sheet at a cost less accumulated depreciation. True or False?
The Correct Answer and Explanation is:
True.
Fixed assets, also known as tangible assets or property, plant, and equipment (PP&E), are typically presented on a company’s balance sheet at their original cost less accumulated depreciation. This method aligns with generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS), which dictate how fixed assets should be valued and reported in financial statements.
Explanation:
When a company purchases a fixed asset, such as machinery, equipment, buildings, or land, the asset is initially recorded at its cost, which includes the purchase price and any additional costs necessary to bring the asset into use (such as installation or transportation fees). This initial cost is referred to as the “historical cost” or “cost basis.”
Over time, fixed assets typically lose value due to wear and tear, obsolescence, or age. To reflect this decrease in value, companies apply depreciation. Depreciation is the systematic allocation of the asset’s cost over its useful life. Each year, a portion of the asset’s value is expensed as depreciation, which reduces the asset’s book value on the balance sheet. The accumulated depreciation represents the total depreciation expense recorded against the asset since its acquisition.
For example, if a company buys a piece of equipment for $50,000 and it depreciates by $5,000 each year for 5 years, after 5 years, the accumulated depreciation would total $25,000, leaving the asset with a net book value (also known as carrying value) of $25,000 on the balance sheet.
The key concept is that the asset is not shown at its original cost but at its “net book value,” which is the historical cost minus the accumulated depreciation. This approach provides a more accurate representation of the asset’s current value and helps companies match expenses to revenues in a more systematic and reasonable manner, in accordance with the matching principle in accounting.
However, it’s important to note that land, which is considered a fixed asset, is not depreciated because it doesn’t typically lose value over time.