Does your 2020 business plan include purchasing fixed assets? Maybe you’re expanding your bakery and will need to buy a new commercial fridge and oven. Or, perhaps you need additional machinery to handle planned growth and new orders.
If it’s been a while since you’ve added fixed assets to your balance sheet, take a moment to review fixed asset accounting. Tax laws have changed recently, and your old templates for booking fixed assets might need to be revised. If you’re planning to purchase fixed assets this year, here’s a refresher of how they’ll impact your accounting.
How to Account for Fixed Assets
A fixed asset is generally defined as land, buildings, or machinery, or any asset with a useful life longer than a year. They’re assets which aren’t easily disposed of, and appear on the Balance Sheet under “non-current assets.”
If you pay cash, you’ll debit the fixed asset account and credit cash to record your new asset. If you finance your purchase, the accounting becomes more complex. You’ll have to set up a new account in your chart of accounts for the loan and record loan payments split between principal and interest. The first entry to add the new asset to your books could split the credit between a cash down payment and a new loan.
After booking the initial purchase, a business will book periodic depreciation entries, impairment write-downs if the asset’s value declines below its net book value, and a disposition entry if it’s sold. Net book value is the asset’s original cost less accumulated depreciation and any impairment, and net book value is how fixed assets appear in financial statements.
When adding a new fixed asset to the books, you’ll need to set up a depreciation schedule. Depending on the size of your business and accounting department, you may decide to book depreciation monthly, quarterly, or annually.
Fixed Asset Management
Once you own an asset, you have to track it. Fixed asset management is the system your business has put in place to monitor its assets. It includes everything from knowing an asset’s physical location to monitoring its value for impairment.
Once you’ve booked your initial purchase of the asset, make sure that it’s added to your fixed asset management software or spreadsheet. Also, add it to your schedule for impairment reviews. Typically, companies choose to evaluate smaller fixed assets for impairment annually, whereas they decide to assess a larger fixed asset quarterly. This is particularly true if there’s reason to believe that the asset’s value could be at risk.
Equipment Financing Pros and Cons
Equipment financing loans allow small business owners to purchase the fixed asset that they need to run their business. An equipment financing lender evaluates your credit, the asset you plan on buying, and its potential resell value to make a lending decision.
There are several pros to taking out an equipment financing loan. The equipment it finances serves as the loan’s collateral. Therefore, the loan will likely have a lower interest rate than other forms of financing, such as an unsecured loan or credit card. Interest rate is a reflection of risk, and loan presents less risk to a lender if they could take possession of collateral and sell it to recoup their losses.
Many times lenders will finance more than 100% of the equipment’s value, including delivery and other charges. This can be helpful if you’re trying to manage cashflow and don’t want to pay these expenses out of pocket.
Lastly, the interest on an equipment financing loan will be tax-deductible. Now, there are limits on the tax-deductibility of qualified interest payments. If your company’s annual revenue is above $25 million, you can only deduct interest up to 30% of adjusted taxable income, which is taxable income, less depreciation and amortization, and interest expense and interest income.
Changes in the tax laws in 2018 had other significant impacts on equipment financing, too. Now, companies with up to a $2.5 million investment in equipment can write off up to $1 million of those purchases. Previously, the limits were $2.0 million and $500,000. Depreciation schedules have also changed for vehicles, with options for companies that do or don’t claim bonus depreciation.
For some companies, leasing will be a more attractive option than purchasing if they are attempting to maximize their tax deductions. Another negative to equipment financing loans is that you could lose that equipment should you default. If the lender chooses to repossess it, your business could be in trouble. As well, you can’t get pre-approved for an equipment financing loan. You must have information on the specific equipment you plan on purchasing to provide the lender when you apply.
Lenders sometimes require an independent appraisal of the capital asset, which could delay the time to funding. This could force you to put expansion plans on hold, or you might have to turn down larger orders if you lack the capacity to fill them.
Depreciation of Fixed Assets
Depreciation reduces the value of an asset over time. Its cost is allocated over an industry-standard period such as two to five years, and slowly the asset is written off to zero.
Before the tax law changes in 2018, companies had to follow a depreciation schedule when writing off capital assets. Now, you can write off the asset’s full expense in the year you acquire it, whether it’s new or used. You do not have to use the modified accelerated cost recovery system (“MACRS"), but can take advantage of this “bonus depreciation.”
The best strategy for your business will depend upon the amount you’re spending on fixed assets and maximizing tax write-offs. With these new changes, it would be wise to enlist the help of a professional tax planner prior to booking a new fixed asset. It might even be a good idea to talk to your accountant before shopping for fixed assets, as they can advise you on buying versus leasing.
Planning for fixed asset purchases has taken on new implications with tax changes, and the old way of doing things may no longer suit your company. Before you call up a lender or visit a dealer, it might be a better idea to call your accountant.