What is the difference between fixed and current assets? Is it necessary to balance them?
If you’re new to balance sheets and accounting, figuring out what the difference is between fixed and current assets can seem like a cumbersome and complicated ordeal.
In the end, the difference between fixed and current assets is the ability of the latter to convert into cash in a short period of time. However, there is more to it than that alone.
Therefore, today we are going to tackle some of the frequently misunderstood components of the balance sheet, fixed and current assets.
First, we’ll break down static and current separately and explain the categories, and then we’ll plot the differences between the two.
What is a fixed asset?
A fixed asset is property with a useful life greater than one reporting period, which exceeds the entity’s minimum capitalization. The fixed asset is not purchased with the intention of immediate resale, but rather for productive use within the entity.
Also, it is not expected to be fully used up within one year of its purchase. An inventory item cannot be considered a fixed asset, as it is purchased with the intent of directly reselling it or being incorporated into a product which is then sold. The following are examples of general categories of fixed assets:
* buildings
* Computer equipment
* computer programs
* Furniture and fixtures
* Intangible assets
* Earth
* Changes in rent
* Machines
* vehicles
Fixed assets are initially recorded as assets and then subject to the following general types of accounting transactions:
* Cyclical depreciation (for tangible assets) or depreciation (for intangible assets)
* Impairment reductions (if the value of the asset falls below its net book value)
* disposition (once the assets are disposed of)
A fixed asset appears in the financial records at its net book value, which is its original cost less accumulated depreciation less any impairment charges.
Due to continuous depreciation, the net book value of an asset always decreases. However, it is possible under IFRS to revalue the fixed asset, so that its net book value can be increased.
A fixed asset does not actually have to be “fixed”, as it cannot be moved. Many fixed assets are portable enough to be moved routinely inside company buildings, or outside the building altogether. Thus, a laptop can be considered a fixed asset (as long as its cost exceeds the capitalization limit).
Fixed asset is also known as property, plant and equipment.
What are the current assets?
An asset is a resource owned or controlled by a company with the expectation of producing future economic benefits. Companies further classify their assets on the balance sheet into current and non-current assets. If it is expected to be converted into cash, consumed through business operations, or disposed of in less than 12 months, it is classified as a current asset.
Non-current assets differ from current assets in the sense that they cannot be practically converted into cash within 12 months of acquisition. Some examples of non-current assets are property, plant and equipment and long-term assets.
* Current assets are resources controlled by an entity that are expected to be converted into cash, consumed by a business or disposed of in less than 12 months
* The balance sheet shows assets in order of their liquidity, i.e. how easily they can be converted into cash without loss in value
* There are many items classified as current assets with cash and cash equivalents being the most liquid
* Current assets are used in calculating liquidity ratios such as the current ratio and the quick ratio, which measure the company’s ability to cover its financial obligations using its current assets.
The difference between fixed and current assets
After we got to know fixed and current assets separately, it is likely that you have already identified the difference between fixed and current assets.
If you haven’t noticed the difference yet, don’t worry!
The main difference between fixed and current assets is their ability to convert into cash and the speed with which this can happen.
As mentioned earlier, fixed assets are usually intangible or long-term, such as a building, land, or even intellectual property, which makes it difficult to convert them into cash in a short period of time.
Current assets are either already cash or can be converted into cash within (usually) one year.
So here’s the main difference, but what else you should know?
Consumption.
Fixed assets may be subject to depreciation, whereas current assets will never be subject to depreciation. This is because fixed assets have a much longer life than current assets, for example, cars will naturally depreciate over their useful lives.
On the other hand, current assets are generally short-lived (or are already cash) and will not be affected by depreciation.
How can I balance my current fixed assets balance?
You may be wondering if there is a balance to be struck between fixed and current assets.
Is it bad to have too many fixed assets and too few current ones? Or vice versa?
Well, the answer to this question is a bit complicated and will vary from industry to industry, but I will do my best to explain it as simply as I can.
The short answer is no. There are many factors that will affect your ability to control the distribution of fixed and current assets.
Software as service businesses may not have as many fixed assets but they may have a greater amount of current assets in the form of surplus cash. This is because transactions are instantaneous and all products sold are online, which means that the only fixed assets that companies like this may have will be in computers, office supplies and supplies.
Having said that, having a lot of fixed assets and not many current assets can be very risky.
This is a risk because of how difficult it is to convert fixed assets into cash in a short period of time.
If you don’t have enough cash or cash equivalents to pay upcoming bills (like your employees’ salaries!) then you may have a problem. It’s not a good idea to own a building worth a million riyals if you can’t use it to pay your upcoming utility bills!
Investors see this as a potential problem as well.
Final words
Today we learned:
* Fixed assets are long-term assets that are illiquid, meaning they cannot be converted into cash quickly (usually within one year)
* Current assets are assets that are short-term or actually cash. These assets are “liquid” meaning that they can easily be converted into cash within one year.
* The difference between fixed and current assets is this ability to convert into cash at a rapid pace.
* The ability to balance your assets between fixed and current assets will depend on many factors such as industry and type of business, so weighting is sometimes unavoidable.
* The current ratio is a way for investors to weigh the risk in placing business assets.
* Having more of your money in fixed assets is potentially riskier from an investor’s point of view as if the company is in financial trouble, it becomes more difficult to raise cash from the assets.
We hope we have clarified some frequently asked questions about these types of assets and provided some information that you may find useful! Remember that this is a very general article and many factors will vary from business to business and industry to industry.
Frequently Asked Questions
The difference between current assets and fixed assets?
Current assets are short-term assets that are usually used in less than one year. Current assets are used in the day-to-day operations of a company to keep it running. Fixed assets are long-term physical assets, such as property, plant and equipment. Fixed assets have a useful life of more than one year
What are examples of fixed assets?
Fixed assets can include buildings, computer equipment, software, furniture, land, machinery, and vehicles. For example, if a company sells a product, the delivery trucks it owns and uses are fixed assets. Note that a fixed asset does not have to be “fixed” in every sense of the word.
How do you define fixed assets?
Fixed assets refer to long-term tangible assets.
The major characteristics of a fixed asset are given below:
1.It has a useful life of more than one year.
2. It can be consumed.
3. They are used in business operations and provide long-term financial benefit.
4. They are illiquid.
Are stocks a fixed asset?
Fixed assets are owned by the company and are used to generate revenue, while stock is a fixed asset because it is reasonable to expect that it can be converted into cash within one business year. From an accounting perspective, fixed assets and inventory inventory represent the property that a company owns.