Payroll Processing and Fixed Asset Procedures:The Conceptual Fixed Asset System

The Conceptual Fixed Asset System

Fixed assets are the property, plant, and equipment used in the operation of a business. These are relatively permanent items that often collectively represent the largest financial investment by the organization. Examples of fixed assets include land, buildings, furniture, machinery, and motor vehicles. A firm’s fixed asset system processes transactions pertaining to the acquisition, maintenance, and disposal of its fixed assets. The specific objectives of the fixed asset system are to:

1. Process the acquisition of fixed assets as needed and in accordance with formal management approval and procedures.

2. Maintain adequate accounting records of asset acquisition, cost, description, and physical location in the organization.

3. Maintain accurate depreciation records for depreciable assets in accordance with acceptable methods.

4. Provide management with information to help plan for future fixed asset investments.

5. Properly record the retirement and disposal of fixed assets.

The fixed asset system shares some characteristics with the expenditure cycle presented in Chapter 5, but two important differences distinguish these systems. First, the expenditure cycle processes routine acquisitions of raw material and finished goods inventories. The fixed asset system processes nonroutine transactions for a wider group of users in the organization. Managers in virtually all functional areas of the organization make capital investments in fixed assets, but these transactions occur with less regularity than inventory acquisitions. Because fixed asset transactions are unique, they require specific manage- ment approval and explicit authorization procedures. In contrast, organizations often automate the authorization procedures for routine acquisitions of inventories.

The second difference between these systems is that organizations usually treat inventory acquisitions as an expense of the current period, while they capitalize fixed assets that yield benefits for multiple peri- ods. Because the productive life of a fixed asset extends beyond one year, its acquisition cost is appor- tioned over its lifetime and depreciated in accordance with accounting conventions and statutory requirements. Therefore, fixed asset accounting systems include cost allocation and matching procedures that are not part of routine expenditure systems.

THE LOGIC OF A FIXED ASSET SYSTEM

Figure 6-11 presents the general logic of the fixed asset system. The process involves three categories of tasks: asset acquisition, asset maintenance, and asset disposal.

Asset Acquisition

Asset acquisition usually begins with the departmental manager (user) recognizing the need to obtain a new asset or replace an existing one. Authorization and approval procedures over the transaction will depend on the asset’s value. Department managers typically have authority to approve purchases below a certain materiality limit. Capital expenditures above the limit will require approval from the higher management levels. This may involve a formal cost-benefit analysis and the formal solicitation of bids from suppliers.

Once the request is approved and a supplier is selected, the fixed asset acquisition task is similar to the expenditure cycle procedures described in Chapter 5, with two noteworthy differences. First, the

receiving department delivers the asset into the custody of the user/manager rather than a central store or warehouse. Second, the fixed asset department, not inventory control, performs the record-keeping function.

Asset Maintenance

Asset maintenance involves adjusting the fixed asset subsidiary account balances as the assets (excluding land) depreciate over time or with usage. Common depreciation methods in use are straight line, sum-of- the-years’ digits, double-declining balance, and units of production. The method of depreciation and the period used should reflect, as closely as possible, the asset’s actual decline in utility to the firm. Account- ing conventions and Internal Revenue Service rules sometimes specify the depreciation method to be used. For example, businesses must depreciate new office buildings using the straight-line method and use a period of at least 40 years. The depreciation of fixed assets used to manufacture products is charged to manufacturing overhead and then allocated to WIP. Depreciation charges from assets not used in manufacturing are treated as expenses in the current period.

Depreciation calculations are transactions that the fixed asset system must be designed to anticipate internally when no external event (source document) triggers the action. An important record used to initiate this task is the depreciation schedule. A separate depreciation schedule, such as the one illustrated in Figure 6-12, will be prepared by the system for each fixed asset in the fixed asset subsidiary ledger.

A depreciation schedule shows when and how much depreciation to record. It also shows when to stop taking depreciation on fully depreciated assets. This information in a management report is also useful for planning asset retirement and replacement.

Asset maintenance also involves adjusting asset accounts to reflect the cost of physical improvements that increase the asset’s value or extend its useful life. Such enhancements, which are themselves capital investments, are processed as new asset acquisitions.

Finally, the fixed asset system must promote accountability by keeping track of the physical location of each asset. Unlike inventories, which are usually consolidated in secure areas, fixed assets are distrib- uted throughout the organization and are subject to risk from theft and misappropriation. When one department transfers custody of an asset to another department, information about the transfer should be recorded in the fixed asset subsidiary ledger. Each subsidiary record should indicate the current location of the asset. The ability to locate and verify the physical existence of fixed assets is an important compo- nent of the audit trail.

Asset Disposal

When an asset has reached the end of its useful life or when management decides to dispose of it, the asset must be removed from the fixed asset subsidiary ledger. The bottom left portion of Figure 6-11 illustrates the asset disposal process. It begins when the responsible manager issues a request to dispose of the asset. Like any other transaction, the disposal of an asset requires proper approval. The disposal options open to the firm are to sell, scrap, donate, or retire the asset in place. A disposal report describing the final disposition of the asset is sent to the fixed asset accounting department to authorize its removal from the ledger.