If you’re new to the balance sheet, comprehending each of its components might seem like a daunting task. While there are current assets and fixed assets on the balance sheet, the question may arise why current assets are called current and why fixed assets are called fixed or non-current?
The primary difference between the two is their capacity to convert into cash quickly.
But the distinction does not end there. This blog will explain the two asset categories, in brief, to show their relevance on the balance sheet, along with an explanation on the depreciation of fixed assets while also highlighting the fixed assets vs. current assets key differences.
What are Fixed Assets?
How can you know if an asset can be converted into cash quickly? The general hypothesis is — if an asset does not convert into cash within one year, it is deemed as a fixed asset. These assets are sometimes tangible, non-liquid, or non-current, simply because they are physical and don’t sell quickly or convert into cash.
In other words, fixed assets describe goods that the business does not anticipate consuming or selling during the current accounting period. These resources are not meant for depletion during manufacturing, and the company does not expect to sell for profit during that fiscal year.
The company’s investments in other firms to develop over time are fixed assets. The company organizes its balance sheet as per its accounting policy which is why there is no one-size-fits-all solution, and thus, it differs from one organization to the next.
Which Assets are the Fixed Assets?
Let’s understand what is included in the fixed assets section of the balance sheet.
- Plant and Machinery, which is a high-value capital item
- Computer and Software
- Furniture and Fittings
- Land and Buildings, where there is no depreciation charged on land
Fixed Assets on the Balance Sheet
Property, plant, and equipment (PPE) holdings appear on the balance sheet on the assets side or under the non-current assets heading. When the firm makes the initial purchase and sells or depreciates the asset, these tangible assets appear in the cash flow statements. Non-current assets, including fixed assets, are defined in a financial statement as those with advantages projected to endure more than one year from the reporting date.
“The net amount for property, plant, and equipment is achieved after subtracting accumulated depreciation from the fixed assets’ original cost.” – Mariusz Skonieczny, founder of Classic Value Investors
Depreciation on the Fixed Assets
Things also age, wear out, or become obsolete. When a company purchases and installs a fixed asset, the countdown to its useful life begins. The depreciation is referred to the wear out of the asset due to its usage over a period.
According to the US GAAP, there are four ways to depreciate an asset, of which straight line and declining balance methods are the most popular ones. Let’s take an example to calculate depreciation under both methods.
A company bought machinery costing $15,000 in January 2020. The machine is expected to work for ten years with a scrap value of $1,000 at the end of 10 years.
Under the straight-line method of depreciation, the depreciation amount is calculated as follows:
Hence, the depreciation in the above example will be $1,400 (15000 – 1000 / 10 years) as per the straight-line method. Moreover, depreciation of $1,400 will be applied for ten years.
Under the declining balance method, the depreciation percentage is calculated to apply to the written-down value each year.
The depreciation percentage in the above example comes to 9.33% ($1400/$15000 *100). Hence, we will apply 9.33% each year on the written-down value of the asset.
For example, in the second year 9.33% is applied to$13,600 ($15,000 – $1,400).
What are Current Assets?
Current assets are the assets that you can quickly convert for cash or have already been realized as cash. These assets are liquid because they are easier to encash and promptly transform into another form.
Current assets on the balance sheet have a more common form than fixed assets> However, they will still vary from industry to industry. Current assets are assets that make day-to-day operations and investments easier.
Which Assets are the Current Assets?
- Let’s understand what is included in the current assets section of the balance sheet
- Cash and Cash Equivalents include cash at the bank and cash on hand
- Inventory, which is the closing balance of the inventory at the end of the financial year
- Accounts Receivables, which are the debtors or customers of the company
- Prepaid Expenses, which are the expenses paid in advance
- Short-term Investments, that have a maturity period of 12 months or less
Current Assets on the Balance Sheet
Managers, analysts, and investors will examine a company’s current assets situation, particularly in comparison to current liabilities, to see if it has adequate liquidity to satisfy short-term commitments like payroll and bills. The examples of liquidity ratios are quick and current ratios.
Fixed Assets Vs. Current Assets – What Are the Differences?
Now, let us understand why fixed assets are called fixed or non-current and why current assets are called current, and the critical differences between them.
The current assets are the ones that you can convert into cash more quickly than the fixed assets. Fixed assets are long-term fixed assets (PP&E) with a useful life of more significant than a year.
Fixed assets have a useful life of more than one year, and they are generally long-term assets.
Current assets have a shorter liquidity period of less than one year. For example, inventories are usually sold within a year, and hence, they come under the heading current assets.
Fixed assets tend to depreciate over time, and there are specific methods to calculate depreciation on fixed assets as per the US GAAP. Whereas current assets do not depreciate or reduce in value. However, accounts receivables are adjusted for any doubtful recovery.
Noncurrent assets (fixed assets) are challenging to convert into cash quickly enough to cover short-term operating needs or investments. Current assets are more liquid and can be converted into cash within one year.
In the case of fixed assets, the business creates a revaluation reserve when the asset value increases. But, there is no formation of such a reserve in the case of a current asset, which is the primary distinction between a fixed asset and a current asset.
Fixed assets are typically financed by a company’s long-term funds or debts, whereas short-term funds or debts are utilized to finance the company’s current assets.
Fixed assets help provide the pledge as security when a company plans to obtain any financial assistance from banks or otherwise. However, you cannot pledge current ones against any loan.
Sale of an Asset
The sale of fixed assets results in a capital profit if sold at a profit and capital loss if sold at a loss. Such a profit or loss is reported under the extraordinary items on a company’s profit and loss statement.
But when current assets are sold, the result is revenue, profit, or loss. It is reported under other income or expense headings depending on whether profit or loss is generated.
Capital investment in fixed assets that produce real goods is the actual driver of long-term economic growth, and until slick financiers hijacked the country with ‘new economy’ mumbo-jumbo based on computer models and hype, most Americans understood this. – Richard Karn
The Bottom Line
To sum up, it is not about the type of asset acquired, but rather the purpose of acquisition. If the company holds the asset for resale, it is a current asset. In contrast, if the asset is acquired to assist the firm in operations for an extended period, it is a fixed asset.