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

Asset Acquisition

Asset acquisition usually begins with the departmental manager (user) recognizing the need to obtain
anew 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.

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-
ofthe-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.

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. 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 ptions 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.

CONTROLLING THE FIXED ASSET SYSTEM

Because of the similarities between the fixed asset system and the expenditure cycle, many of the
controls are the same and have already been discussed. Our discussion of fixed asset controls will thus
focus on three areas of principal difference between these systems: authorization, supervision, and
independent verification.

1. Authorization Controls

Fixed asset acquisitions should be formal and explicitly authorized. Each transaction should be initiated
by a written request from the user or department. In the case of high-value items, there should be an
independent approval process that evaluates the merits of the request on a cost-benefit basis.

2. Supervision Controls

Because capital assets are widely distributed throughout the organization, they are more susceptible to
theft and misappropriation than inventories that are secured in a warehouse.

3. Independent Verification Controls

Periodically, the internal auditor should review the asset acquisition and approval procedures to
determine the reasonableness of factors used in the analysis. These include the useful life of the asset,
the original financial cost, the proposed cost savings as a result of acquiring the asset, the discount rate
used, and the capital budgeting method used in the analysis.