If you’ve been self-employed for a while, your business has likely accumulated a few fixed assets. In fact, chances are your business has fixed assets even if you’ve just started out.But, you may be wondering, what are fixed assets exactly? How are they different from other types of business assets? And, more importantly, how do you account for them?Let us explain.
What is an asset?
Let’s start at the very beginning. Put simply, an asset is a valuable piece of property. There are two main types of assets in business: fixed assets and current assets. We’ll explain the difference shortly.
What are fixed assets?
Fixed assets are assets that’ll benefit your business in the long term. FRS 102 — the Financial Reporting Standard applicable in the UK and Republic of Ireland — defines them as assets you plan on using in your business on a continual basis.Fixed assets can be tangible or intangible. Here’s how to distinguish between the two.
Intangible fixed assets
Intangible fixed assets are assets that don’t have physical substance. Examples include:
Experienced employees or contracts with skilled suppliers
Your brand name and goodwill, that is your reputation as an established business
Typically, you’d create intangible fixed assets in-house over time. For this reason, you don’t usually include them in your accounts (do note, however, that you’d include intangible fixed assets in your accounts if you buy them from someone else).
That said, you won’t be surprised to hear that these assets can make your business much more valuable.Case in point, Amazon's reputation gives it an edge over other online retailers. Similarly, a long-term government contract means your business will probably be profitable for several years. And this will make it more valuable than businesses that don’t have government contracts or other big clients.
Tangible fixed assets
Tangible fixed assets, or capital assets, can be property, plant or equipment. They include:
Warehouses, factories, shops, offices or other business premises you own
Land or other property
Cars, vans and other business vehicles
Equipment you use in your business, such as your laptop, special software, office furniture or machinery you use to manufacture your products
Unlike intangible fixed assets, you typically have to buy tangible fixed assets. This means you’ll probably want to include them in your accounts. We’ll talk about how tangible fixed assets affect your finances in a minute.
What items are considered tangible fixed assets?
HMRC don’t have specific rules on what is or isn’t a tangible fixed asset. According to their latest toolkit, this depends on your business and circumstances.That said, a tangible fixed asset will usually be something that:
Belongs to your business. So, if you buy a company car through your limited liability company, the car would be one of your company’s tangible fixed assets. Similarly, if you’re a baker, your fridges and ovens would count as tangible fixed assets.
You’ve bought for a relatively high price. How high is high enough will depend on your business. £200 may be a lot of money if you’re a sole trader who’s just starting out. On the other hand, if you’re a company with 50 offices nationwide, £200 is probably a drop in the ocean.
Unlike fixed assets, current assets are assets that benefit your business in the short term. They include:
Cash, including any foreign currency deposits you might have, such as payments from international clients.
Investments (do note, however, that only investments you can sell off easily are current assets. Long-term investments such as property would count as fixed assets).
Accounts receivable. This is money you’re yet to receive from your clients. For example, because they haven’t paid your invoice yet.
This includes your stock, raw materials you use to manufacture your products and work-in-progress. For example, a project you’re working on but haven’t delivered yet.
So what’s the difference between current and fixed assets?
As you’ve probably realised, the main difference between current and fixed assets is time. Current assets are either cash or assets you’ll be converting to cash in less than a year’s time. By contrast, you probably won’t convert your fixed assets to cash for at least a year.
How do I account for fixed assets I’ve bought for my small business?
When you buy something for your business, you typically deduct it from your income. Unfortunately, you cannot deduct fixed assets in this way, as you would an expense such as business mileage or utilities.The reason for this is simple. While buying them costs money, fixed assets add long-term value to your business. As a result, they’re not technically expenses.So how do you account for fixed assets?You use a process called capitalisation.
What is capitalisation?
Capitalisation means recording a purchase as an asset instead of an expense. To do this, you include the purchase price in your business’s balance sheet, instead of your profit and loss account. The upshot is that your asset’s purchase price doesn’t lower your income for the financial year.
Does this mean I can’t deduct the cost of fixed assets from my taxes?
The simple answer is: it depends. In the UK, HMRC allows you to deduct the cost of fixed assets from your taxes by claiming capital allowances. The catch is that not all fixed assets are eligible. For example, you can’t claim capital allowances if you purchase office space.You can claim capital allowances on the following seven types of fixed assets:
Plant and machinery. This includes:
Equipment, machinery and business vehicles
The cost of demolishing them
Features that are integral to a building or structure, that is lifts, escalators and moving walkways, heating and air conditioning systems, hot and cold water systems, electrical and lighting systems and external solar shading
Fixtures, such as kitchens, bathrooms, CCTV and fire alarms
Patents. These recognise you as an inventor and give you the sole and exclusive right to use your invention
You can claim capital allowances in one of two ways: through the annual investment allowance or using writing down allowances.We’ve written an in-depth article about capital allowances and how to claim them. But if you don’t have time to read it, here’s a brief summary.
Annual investment allowance
The annual investment allowance allows you to deduct the purchase price of fixed assets you buy for your business, up to a value of £200,000 per year.Let’s say you make £70,000 after expenses in 2018/19. You spend £30,000 on machinery for your business. Since this is less than £200,000, you can deduct it from your income. As a result, you’d pay tax only on £40,000.
Writing down allowances
Have you spent more than £200,000 on fixed assets in a given tax year? You can claim writing-down allowances on the remainder.You can also claim writing down allowances on fixed assets that the annual investment allowance doesn’t cover. These are:
Cars
Assets you owned before you started your business
Gifts
Claiming writing down allowances is slightly more involved than claiming the annual investment allowance. You’ll need to:
Find out how much your asset is worth. This is what you paid for it. Or, if it’s a gift or something you owned before you started your business, it’s the market value.
Find out which ‘pool’ the asset should go in. HMRC has three ‘pools’ — main rate, special rate and single asset. How much you can claim will depend on which pool your asset fits into. You can claim 18 percent of the asset’s value per year on main rate pool items, 8 percent per year on special rate pool items and 18 or 8 percent per year on single asset pools.
If you’re a sole trader or in a partnership, deduct personal use.
What about depreciation?
Over time, some fixed assets will go down in value — a process called depreciation. This could be for various reasons, including:
Wear and tear.
Your asset becomes obsolete, for example because a new, better version has come out.
Your asset has a limited lifespan. For example, it’s a contract that expires after five years.
Your asset is a natural resource that will eventually run out.
Unfortunately, HMRC doesn’t take depreciation into account when calculating your taxes. This is because you can claim the annual investment allowance or writing down allowances instead.That said, calculating depreciation is still useful because it tells you how much your fixed assets are worth over time.
How do I calculate depreciation?
You can calculate depreciation using one of two methods: straight-line depreciation or reducing balance depreciation.Let’s have a look at each in turn.
Straight line depreciation
In straight-line depreciation, you deduct the same amount of money from your asset’s value each year. This method works especially well when you know the asset’s exact lifespan.Let’s say you have a business contract worth £100,000. The contract is for a term of five years, after which you can’t renew it.To calculate depreciation using the straight-line method, you’d divide £100,000 by five. So, the asset will depreciate by £20,000 every year.
Reducing balance depreciation
This method is useful if you don’t know exactly how much your asset will last. It also works well if you expect your asset’s depreciation to vary.Cars are a typical example of this. According to the AA, a new car loses as much as 40 percent of its value in its first year on the road. But, over the next few years, depreciation will usually slow down.
To calculate depreciation using the reducing balance method, you’ll need to pick a percentage rate of depreciation. This will depend on the asset. Some assets, such as cars and laptops, depreciate faster than others.Once you’ve picked your percentage rate of depreciation, use it to deduct a part of your asset’s value every year. This process is exactly the same as calculating a writing down allowance.
Let’s say you buy a laptop for £1,000. The rate of depreciation is 25 percent. So, it would depreciate as follows:
Year 1: 25 percent of £1,000, that is £250. So, at the end of year one, the laptop is worth £750.
Year 2: 25 percent of £750, that is £187.50. This means the laptop is now worth £562.50.
Year 3: 25 percent of £562.50, that is £140.63. This means the laptop is now worth £421.87.
And on and on every year until the laptop’s value is zero.
All clear? Bet that wasn’t as complicated as you thought it was, right?
