Fixed assets are long-term tangible assets that a business uses for operations, such as buildings, machinery, and vehicles. Over time, these assets may experience a fall in value due to various factors such as wear and tear, obsolescence, or economic conditions. Proper accounting treatment of asset value reductions ensures that financial statements reflect the true financial position of a business.
1. Reasons for a Fall in Value of Fixed Assets
A. Depreciation
Depreciation is the systematic allocation of an asset’s cost over its useful life. As the asset is used, its value decreases.
B. Obsolescence
Technological advancements may render assets outdated, leading to a decrease in their usefulness and market value.
C. Wear and Tear
Physical deterioration due to regular use or aging causes assets to lose value over time.
D. Market Conditions
Changes in economic conditions, such as property price fluctuations, may affect the value of fixed assets.
E. Damage or Impairment
Unexpected events like accidents, fire, or natural disasters can cause a sudden reduction in asset value.
2. Accounting for the Fall in Value of Fixed Assets
A. Depreciation Accounting
Depreciation is recorded annually to reflect the decrease in asset value due to normal usage.
Journal Entry for Depreciation:
Debit: Depreciation Expense
Credit: Accumulated Depreciation
B. Revaluation Loss
If an asset is revalued downward due to market conditions, the decrease is recorded as a Revaluation Loss.
Journal Entry for Revaluation Loss:
Debit: Revaluation Reserve (if available)
Debit: Impairment Loss (if no reserve)
Credit: Fixed Asset Account
C. Impairment Loss
An impairment loss occurs when an asset’s recoverable amount is lower than its book value.
Formula:
Impairment Loss = Book Value – Recoverable Amount
Journal Entry for Impairment:
Debit: Impairment Loss
Credit: Fixed Asset Account
3. Example of Fixed Asset Value Reduction
Scenario 1: Depreciation
A business purchases a machine for $50,000 with a useful life of 10 years and no residual value.
Annual Depreciation = $50,000 ÷ 10 = $5,000 per year
Journal Entry:
Debit: Depreciation Expense $5,000
Credit: Accumulated Depreciation $5,000
Scenario 2: Impairment Loss
The same machine is damaged and its recoverable amount is now $30,000, while its book value is $40,000.
Impairment Loss = $40,000 – $30,000 = $10,000
Journal Entry:
Debit: Impairment Loss $10,000
Credit: Fixed Asset Account $10,000
4. Impact of a Fall in Value on Financial Statements
A. Balance Sheet
- Asset values decrease, reducing total assets.
- Accumulated depreciation increases.
- Impairment losses lower net asset value.
B. Income Statement
- Depreciation and impairment expenses reduce net profit.
C. Cash Flow Statement
- Depreciation and impairment are non-cash expenses added back in operating activities.
5. Preventing a Rapid Fall in Asset Value
- Regular maintenance and servicing.
- Timely upgrades to avoid obsolescence.
- Proper insurance coverage.
Managing the Fall in Fixed Asset Value
Businesses must account for the fall in value of fixed assets through depreciation, impairment, or revaluation. Proper recording ensures financial statements reflect the true economic value of assets and prevent overstatement of financial position.