Accountng: The Language of Business (Part 64)

Skill at creating, exploiting, and exiting crucial alliances beats ownership of fixed assets 

Tom Peters

 Fixed Assets and Intangible Assets (Part H)

by

Charles Lamson

Leasing Fixed Assets

You are probably familiar with Lisa's. A lease is a contract for the use of an asset for a stated period of time. Leases are frequently used in business. For example, automobiles, computers, medical equipment, buildings, and airplanes are often leased.

The two parties to a lease contract are the lessor and the lessee. The lessor is the party who owns the asset. the lessee is the party to whom the rights to use the asset are granted by the lessor. The lessee is obligated to make periodic rent payments for the lease term. All leases are classified by the lessee as either capital leases or operating leases.

A capital lease is accounted for as if the lessee has, in fact, purchased the asset. The lessee debits an asset account for the fair market value of the asset and credits a long-term lease liability account. The asset is then written off as expense (amortized) over the life of the capital lease.

A lease that is not classified as a capital lease for accounting purposes is classified as an operating lease. The lessee records the payments under an operating lease by debiting Rent Expense and crediting Cash. Neither future lease obligations nor the future rights to use the leased asset are recognized in the accounts. However, the lessee must disclose future lease commitments in notes to the financial statements.

The asset rentals described in preceding posts were accounted for as operating leases. To simplify, we will continue to treat asset leases as operating leases. 

Internal Control of Fixed Assets

Because of their dollar and long-term nature, it is important to design and apply effective internal controls over fixed assets. Search controls should begin with authorization and approval procedures for the purchase of fixed assets. Controls should also exist to ensure that fixed assets are acquired at the lowest possible costs. One procedure to achieve this objective is to require competitive bids from three approved vendors.

As soon as a fixed asset is received, it should be inspected and tagged for control purposes and recorded in a subsidiary ledger. This establishes the initial accountability for the asset subsidiary. Subsidiary ledgers for fixed assets are also useful in determining depreciation expense and recording disposals. Operating data that may be recorded in the subsidiary ledger, such as number of breakdowns, length of time out of service, and cost of repairs, are useful in deciding whether to replace the asset. The company that maintains a computerized subsidiary ledger may use bar-coded tags, so that fixed asset data can be directly scanned into computer records.

Fixed assets should be insured against theft, fire, flooding, or other disasters. they should also be safeguarded from theft, misuse, or other damage. for example, fixed assets that are highly open to theft, such as computers, should be locked or otherwise protected when not in use. For computers, safeguarding also includes climate controls and special fire extinguishing equipment. Procedures should also exist for training employees to properly operate fixed assets such as equipment and machinery.

A physical inventory of fixed assets should be taken periodically in order to verify the accuracy of the accounting records. Such an inventory would detect missing, obsolete, or idle fixed assets. In addition, fixed assets should be inspected periodically in order to determine their condition.

Careful control should also be exercised over the disposal of fixed assets. All disposals should be properly authorized and approved. Fully depreciated assets should be returned in the accounting records until disposal has been authorized and they are removed from service. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 408-410*

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