Fixed Assets Primer: The Essentials for Managing Fixed Assets FIXED ASSETS PRIMER: The Essentials for Managing Fixed Assets

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1 FIXED ASSETS PRIMER: The Essentials for Managing Fixed Assets 1

2 Table of Contents About Bloomberg BNA s Software Products 3 About Bloomberg BNA 3 About the Author 3 Introduction 4 Chapter 1: What is Fixed Assets Management? 5 What is an Asset/Fixed Asset? 5 The Fixed Assets Life Cycle 6 Adding Assets 6 Adjusting Assets 6 Depreciating Assets 6 Transferring Assets 6 Disposing of Assets 6 Chapter 2: Calculating and Managing Depreciation 8 Financial Accounting versus Tax Accounting 8 Calculating Depreciation 8 Seven Key Pieces of Information 8 Section 179 Expense 12 Bonus Depreciation 12 Chapter 3: Reconciliation and Reporting 13 Period and Year-End Close 13 Calculating Gain or Loss on the Disposition of Assets 13 Standard Reporting 14 Financial Projections and Planning 14 Chapter 4: Tracking and Controlling Asset Data 15 The Importance of an Audit Trail 15 What are Internal Controls and Why are They so Important? 15 Protecting Your Data 15 Policy Documentation 16 Chapter 5: Fixed Assets Management Software 17 The Role of the General Ledger System 17 The Role of the ERP System 17 Fixed Assets Management Software 17 A Word about Spreadsheets 18 Spreadsheet Risk Diagnostic Tool 19 Chapter 6: Inventory Audit 20 Ensuring the Accuracy of Asset Information 20 Conducting a Physical Inventory 20 Reconciling with Accounting Records 21 Ongoing Asset Management and Control 21 Asset Inventory Process Checklist 21 Appendix: Resources 22 BNA Fixed Assets 22 BNA Asset Inventory 22 2

3 About Bloomberg BNA s Software Products Bloomberg BNA offers expert software products for tax and accounting professionals. With category-leading software and top-rated technical support, we are the solution of choice for professional firms and corporations of every size. More than 70,000 customers, including the IRS, depend upon Bloomberg BNA s software products for the highest degree of tax, regulatory, and compliance expertise available in the market. About Bloomberg BNA Bloomberg BNA, a wholly owned subsidiary of Bloomberg, is a leading source of legal, regulatory, and business information for professionals. Its network of more than 2,500 reporters, correspondents, and leading practitioners delivers expert analysis, news, practice tools, and guidance the information that matters most to professionals. Bloomberg BNA s authoritative coverage spans the full range of legal practice areas, including tax & accounting, labor & employment, intellectual property, banking & securities, employee benefits, health care, privacy & data security, human resources, and environment, health & safety. About the Author Nancy Faussett, CPA, has more than 25 years of tax accounting experience. Nancy joined Bloomberg BNA s software products in 2001, serving as an in-house expert on fixed assets, depreciation, and various areas of corporate and individual income taxation for over a decade. Nancy has also been published in Strategic Finance and the ACT Journal. Previously she was vice president of tax preparation for General Business Services and later worked as a depreciation and tax specialist BNA Software, a division of Tax Management Inc. All rights reserved. 3

4 Introduction In today s current regulatory and highly competitive business environment, asset management is taking on far greater importance than in the past, with closer scrutiny of return on investment as well as full disclosure of financial asset information. That said, asset accounting is a complex and sometimes seemingly inscrutable subject, with gray areas ripe for varying interpretations. In fact, many professionals readily admit that fixed assets accounting is one of the more complex areas of financial accounting. And to prove that, while nearly every accountant will claim to know exactly what an asset is, there are often differences of opinion about whether a particular item is in fact an asset and should be included on the balance sheet. sure their internal controls are adequate. It only makes sound accounting sense to do so. What to expect in this book This e-book provides an overview of fixed assets management and illustrates why it is important to exercise control to ensure accuracy of fixed assets information. It is not intended to be an exhaustive text on all of the intricacies and details of fixed assets accounting and tax reporting. For that, it is recommended that you refer to sources from professional associations and government agencies for the latest accounting regulations and government mandates and laws regarding fixed assets. There are a multitude of rules and regulations affecting how fixed assets can be handled. And, as if Generally Accepted Accounting Principles (GAAP) rules and federal tax laws aren t enough to keep track of, you also have to be aware of how state tax law treats fixed assets. Some states accept everything the federal tax law does, but many states reject all or at least part of the federal regulations. Keeping current on all of this can be overwhelming to any business, especially since the rules and regulations keep changing. While the concept of an asset is fundamental to business accounting, for many organizations fixed assets management is still one of the weakest areas of internal controls resulting in overpayment of taxes and insurance, higher total costs of ownership, missed opportunities for income tax deductions, and the risk of noncompliance with regulatory mandates. Since the passage of the Sarbanes-Oxley Act (SOX), accounting controls for public companies have been strengthened but even privately held companies want to be 4

5 Chapter 1 What is Fixed Assets Management? What is an Asset/Fixed Asset? Before we discuss fixed assets accounting and management, let s make sure there s a clear understanding of what an asset is and what makes an asset a fixed asset. First of all, an asset is a basic unit of economic value that is expected to provide benefit beyond a single period. The value of the asset is recorded on the company balance sheet (unless its cost is an immaterial amount). Examples of assets are cash, accounts receivable, inventory, prepaid insurance, land, buildings, equipment, trademarks and customer lists purchased from another company, and certain deferred charges. There are two major asset classes: tangible assets and intangible assets. In addition, there are subclasses of these assets. Tangible assets are classified as either current assets or fixed assets. Current assets include inventory and receivables, while fixed assets include buildings, property, and equipment. Fixed assets can be further divided into two types: Real property: includes buildings, land, and anything attached to the land Personal property: includes everything else, namely moveable property, such as machinery and equipment Intangible assets are nonphysical resources such as goodwill, copyrights, trademarks, patents, and financial assets, including accounts receivables, bonds, and stocks. Both tangible assets and intangible assets generally decrease in value over time as their economic usefulness lessens. When this occurs, tangible assets are depreciated and intangible assets are amortized (although for GAAP, intangible assets may be subject to a write down for an impairment loss instead). For the rest of this e-book, we ll focus on the class of tangible assets called fixed assets. Also referred to as PPE (property, plant, and equipment), fixed assets are acquired by a business to assist in earning profits. This includes land, buildings, manufacturing equipment, office equipment, furniture, fixtures, and vehicles. They are generally written off against profits over their anticipated, useful life (or, for tax purposes, over a mandated IRS recovery period) by charging depreciation expense (with the principal exception being land assets). Asset: A basic unit of economic value that is expected to provide benefit beyond a single period Fixed Asset: Tangible assets such as land, buildings, manufacturing equipment, office equipment, furniture, fixtures, and vehicles 5

6 Chapter 1 What is Fixed Assets Management? The Fixed Assets Life Cycle As with any business asset, the idea is to maximize the return on investment. To do this, a company needs to have effective management and control of all the fixed assets it owns. According to industry analysts and experts, organizations that practice effective asset management have a lower total cost of ownership, with reduced procurement, disposal, operations, and other costs. Let s look now at the life cycle of fixed assets to get a better understanding of what it means to track and manage them. Fixed Assets Life Cycle Add Adjust (optional) Depreciate Dispose or Transfer Comprehensive Financial and Tax Reporting Adding Assets An asset is most often entered into the accounting system when the invoice for the asset is entered into the accounts payable or purchasing part of the application. Most of the information needed to set up the asset for depreciation is available at the time the invoice is entered, including: acquisition date, placed-in-service date (which may be different from the acquisition date), description, asset type, cost basis, and depreciable basis. Some fixed assets management software will automatically enforce company policies for depreciation method and other attributes based on the asset type selected. If that s not the case in your company, it s important that everyone adding assets understands company depreciation policies and consistently follows them for every asset. Adjusting Assets Even when all the necessary information is accurately entered when the asset is added to the accounting system, adjustments often need to be made. Events may occur that can change the depreciable basis of an asset and require an adjustment be made to it. Initially, there is the cost of freight and any installation charges that increase the asset s basis. Salvage value, depending on the depreciation method used for financial reporting, may require a reduction to the asset s basis. If depreciating an asset for tax purposes, certain tax credits or special partial expensing may also reduce the asset s depreciable basis. Later during the asset s life there may be improvements or repairs made to it that either add value to the asset or extend its economic life and these, too, must be added to the asset s basis. Depreciating Assets There is so much to cover when it comes to depreciation that the whole next chapter is devoted to this subject. Transferring Assets Sometimes a fixed asset is transferred to another subsidiary, reporting entity, or department within the company. These intercompany and intracompany transfers may result in changes that impact the asset s depreciable basis, depreciation, or other asset data. This needs to be reflected accurately (and tracked) in the accounting or fixed assets management system. Disposing of Assets When a fixed asset is no longer in use, becomes obsolete, and/or is beyond repair, the asset is typically disposed or taken out of service. When an asset is taken out of service, depreciation on it stops. There are multiple 6

7 Chapter 1 What is Fixed Assets Management? types of disposals such as abandonments, sales, and trade-ins (which may be either taxable or nontaxable exchanges). The asset s cost and accumulated depreciation is removed from the general ledger and the amount received is recorded. Any difference is reported as a gain or loss. We ll cover gain/loss reporting in more detail in Chapter 3. In certain cases, there may be a partial disposal of an asset. For example, a business purchased five laptops and originally depreciated them as one asset in the financial data. Over time, if two of those computers become obsolete or beyond repair, then typically, the individual asset (that represents the five laptops) is broken into multiple parts based on the individual asset cost basis. Then the two obsolete laptops are disposed while the other three laptops will continue to be depreciated over the remaining recovery period. Example: A classic example that requires an adjustment is the purchase of equipment for which a rebate is received from the manufacturer several months after the asset is placed into service. In such a case, the asset is generally added with its original full acquisition cost and the rebate lags behind by several months. Once the rebate is received, the corporate accountant needs to make an adjustment to the cost basis of the asset to ensure that the depreciation calculations are correct. Here s how the adjustment process works for this example: 1. Company ABC purchased an air conditioning unit for $120,000 and placed it into service on January 1. Assuming a ten-year service life for GAAP purposes and straight-line depreciation, the company should record $1,000 of depreciation expense each month. The company closes its books at the end of February and posts $2,000 of depreciation expense for the first two months. 2. In March, the company receives a rebate of $30,000 for having purchased the air conditioning unit. The accounting department then needs to adjust the cost basis of the asset to $90,000 starting in March. Further depreciation calculations should reflect the appropriate treatment based on the new basis. 3. Assuming that this is the only asset in Company ABC, the asset balance reconciliation at the Period 2 close should be as follows: Beginning Balance Additions Adjustments Disposals Transfers Ending Balance $120K $0 -$30K $0 $0 $90K Note that this reconciliation is only possible because Company ABC knows the original basis of the air conditioner, even after adjusting its basis in a subsequent period. This illustrates the importance of having a good audit trail, which we ll cover in a subsequent chapter. 7

8 Chapter 2 Calculating and Managing Depreciation Financial Accounting versus Tax Accounting The decline in an asset s economic and physical value is called depreciation. According to Generally Accepted Accounting Principles (GAAP), depreciation is an expense that must be periodically reflected on a company s books and allocated to the accounting periods to match income and expenses. However, depreciation based on GAAP principles and reported on a company s financial statements can be different than the depreciation based on the Internal Revenue Service (IRS) tax code and regulations. This means that companies will usually have to manage and track depreciation separately for tax and accounting purposes. Furthermore, for income tax reporting purposes, depreciation must be calculated differently for different requirements. For example, there are different depreciation methods and recovery periods required when calculating the Alternative Minimum Tax (AMT), Adjusted Current Earnings (ACE), Earnings and Profits (E&P), and regular federal taxable income. There are also other restrictions often set by the individual state departments of revenue for their own filing requirements. Calculating Depreciation Financial and tax depreciation rules are complicated, time-dependent, and continually subject to change. As proof, there are five complete volumes of Bloomberg BNA Tax Management Portfolios devoted to depreciation and amortization, explaining the rules just for federal tax purposes. The following discussion of depreciation provides an overview of depreciation methods, but a more thorough understanding of the tax code is necessary to determine the most tax advantageous method for a particular asset or class of assets owned by your company. Alternatively, good fixed assets management software can provide guidance and ensure compliance with the latest rules and regulations. Seven Key Pieces of Information Before you can begin calculating depreciation, you need seven key pieces of information: Depreciable basis of the asset Estimated useful life of the asset (or assigned recovery period) Placed-in-service date Type of property Salvage value (if certain depreciation methods are used under GAAP) Averaging convention Depreciation method 8

9 Chapter 2 Calculating and Managing Depreciation 1. Depreciable Basis The depreciable basis, for GAAP purposes, is calculated as follows: Depreciable basis = Cost of the fixed asset + sales tax + shipping and delivery costs + installation charges + other miscellaneous costs (commissions, finder s fees, etc.) times business-use percentage minus salvage value if either the straight-line or sum-of-the-years -digits method is used. The depreciable basis, for tax purposes, is calculated the same as for GAAP except that salvage value is ignored and certain tax credits, as well as any Section 179 expense or bonus depreciation claimed (discussed later), will reduce the asset s basis. In later years, the cost of any repairs adding value or lengthening the asset s life will increase the asset s depreciable basis. Also, certain depreciation methods require prior accumulated depreciation to be deducted from the depreciable basis before subsequent calculations can be made. the asset is depreciated over a statutory recovery period based on the type of asset and the year in which it is placed in service. 3. Placed-in-Service Date The placed-in-service date is when depreciation on an asset begins. The asset must be installed and operational for depreciation to start. Rental property, for example, must be available to be rented (however, not being rented yet will not prevent it from being depreciated). 4. Type of Property The type of property is most important when selecting a depreciation method and recovery period for tax purposes. For tax purposes, only certain depreciation methods and recovery periods may be used for certain types of property. For financial purposes, the type of property simply helps you to determine a reasonable expected useful life and depreciation method for the asset. 5. Salvage Value Salvage value is the amount the asset is worth or can be expected to be sold for at the end of its useful life, less any removal and selling costs. The latter explains why a building almost never has salvage value as the cost of demolition usually outweighs the value of any material recovered. Salvage value is only deducted for the straight-line, sum-of-the-years -digits, and units-of-production depreciation methods. Furthermore, there are declining-balance methods used for financial purposes which require that the asset not be depreciated below its salvage value. Salvage value is not used when depreciating an asset under the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. 2. Useful Life The number of years over which an asset is depreciated may be different for financial versus tax purposes. For financial purposes, a realistic estimated useful life is used. For tax purposes, 9

10 Chapter 2 Calculating and Managing Depreciation 6. Averaging Convention Averaging conventions are used both in the year a depreciable asset is placed in service and the year in which it is disposed (if disposed of before the end of its depreciable life). Averaging conventions effectively prorate the otherwise annual amount of depreciation allowed. For financial reporting, their use is simply based on consistency and whatever makes sense to the taxpayer. For tax reporting, the type of averaging convention used is mandated by the IRS code and is based either on the type of property or whether the taxpayer placed a large amount of property in service in the last three months of the year. The three types of averaging conventions used for tax purposes are: Half-year convention: Treats the asset as either placed in service or disposed on the mid-point of the taxable year Mid-month convention (used for most real property): Treats the asset as either placed in service or disposed on the mid-point of the month in which the event occurred Mid-quarter convention (used when more than 40% of the taxpayer s property is placed in service during the last three months of the year): Treats the asset as either placed in service or disposed on the mid-point of the quarter of the year in which the event occurred ages and/or there is a high risk of obsolescence. The units-of-production method is used when usefulness decreases with the asset s usage instead of the asset s age. The Modified Accelerated Cost Recovery System (MACRS) is required to be used to depreciate most property for tax reporting purposes. There are two systems under MACRS: the General Depreciation System (GDS), which is used most of the time, and the Alternative Depreciation System (ADS). The principal difference between these two systems is that ADS generally uses longer recovery periods and always uses the straight-line depreciation method. In addition, ADS is only used if the business elects to use it or for certain property types (such as tax-exempt use property) as required by law. 7. Depreciation Method Because there is a wide variation in the physical and economic characteristics of assets, GAAP allows several depreciation methods: straight-line, sum-of-the-years -digits, declining-balance, and units-ofproduction (or activity method). In general, companies use the straight-line method when the benefit of the asset is expected to be uniform over the life of the asset. An accelerated approach (sum-of-the-years -digits and declining-balance methods) is used when the asset is most productive in the earlier years of its lifespan. Other reasons to use an accelerated approach is when maintenance costs are expected to increase as the asset 10

11 Chapter 2 Calculating and Managing Depreciation Straight-line Method The simplest type of depreciation to calculate is straight-line depreciation. It spreads out the cost of the asset evenly over its entire useful life. To calculate straight-line depreciation for an asset, you divide the depreciable basis (total asset cost salvage value) of the asset by its estimated useful life in years. Depreciable basis/life = Annual Straight-line Depreciation Sum-of-the-years -digits Method (SYD) This is an accelerated depreciation method used when an asset loses the majority of its value in the first several years of use. For instance, transportation companies often use this depreciation method for vehicles they purchase. To calculate the sum-of-the-years -digits method, you multiply the depreciable basis by a fraction. The denominator of the fraction is determined by summing the digits in the years of the asset s expected life and the numerator is the number of years remaining in the asset s useful life. Depreciable basis x (Remaining years/sum of the years digits) = Annual Sum-of-the-years - digits Depreciation For example: For an asset with a 10-year useful life the digits are: The sum of all those digits is 55. So, in the first year, the asset would be depreciated 10/55 in value (the fraction 10/55 is equal to 18.18%), then 9/55 (16.36%) in the second year, 8/55 (14.54%) in the third year, etc. Declining-Balance Method (DB) Another accelerated depreciation method, the declining-balance method is calculated by multiplying the asset s net book value (the remaining depreciable basis, after deducting all prior depreciation) each year by a fixed rate. The most common rate used is double the straight-line rate, which is why this is referred to as the double-declining-balance method. The 1.5 declining-balance method is equal to one and a half times the straight-line rate. The declining-balance method does not deduct any salvage value when calculating the depreciable basis; however, the asset cannot be depreciated below its salvage value. Because the decliningbalance method never fully depreciates the asset, companies using this method often switch to the straight-line method later in the asset s life for assets that have no salvage value and which they want to fully depreciate. To calculate the depreciation factor you divide 1 by the estimated useful life in years and then double that rate to use the doubledeclining balance method. Then to calculate the depreciation, you multiply the net book value at the beginning of each year by the depreciation factor. The depreciation factor is the same for each year. For example, an asset has an original cost of $1,000, a salvage value of $100 and a five-year useful life. The straight-line depreciation rate is 1/5 =.20 (or 20%). Doubling this rate would result in a depreciation rate of 40%. The first year of depreciation would then be $1,000 (book value) x 40% = $400. The second year would be $600 (net book value) x 40% = $240 and so on. Units-of-Production (UOP) or Activity Method This method is based on activity, or usage patterns, and not on the passage of time. The life of the asset is estimated based on activity such as miles driven or cycle count or by how much of something is produced. The calculation for depreciation based on activity or production is: Depreciable basis (original cost salvage value)/ Total estimated number of units to be produced or used during the estimated useful life x actual units produced (or used) this year = Annual Units-of-Production Depreciation. MACRS For tax purposes, there are several ways to depreciate assets under MACRS, based on different combinations of depreciation methods and recovery periods. They use either the declining-balance method (always changing 11

12 Chapter 2 Calculating and Managing Depreciation to straight-line depreciation during the last years of the recovery period, so that the asset is eventually fully depreciated) or the straightline method. They all use an assigned recovery period based on the type of property and the year it is placed in service (since the IRS rules often change over time). The recovery period is either the asset s assigned GDS life or its ADS life. These mandated recovery periods are published in the IRS ADR Class Life Table. The following are ways under MACRS to depreciate assets, listed in descending order, according to their speed of recovering the asset s depreciable basis: Double-declining balance over the asset s GDS recovery period. This is used for 3-, 5-, 7-, and 10-year classes of property. 1.5 declining balance over the asset s GDS recovery period. This is used for 15- and 20- year classes of property and all farm property. An election to use 1.5 declining balance over the asset s GDS recovery period. This may be used for 3-, 5-, 7-, and 10-year classes of property. Straight-line over the asset s GDS recovery period. This is required for 25-, 27.5-, 31.5-, and 39-year classes of property (and, also, for trees and vines that bear fruit or nuts) and may be elected for any other property. Straight-line over the asset s ADS recovery period. This is required for certain types of property and may be elected for all others. Section 179 Expense For tax reporting purposes, a qualifying taxpayer can choose to treat the cost of certain property as an expense and deduct it in the year the property is placed in service instead of depreciating it over several years. Qualifying property is frequently referred to as Section 179 property. Any Section 179 expense claimed on an asset reduces the asset s depreciable basis. There is a maximum dollar amount that may be claimed each year on newly acquired property that qualifies for the deduction. In addition, there are both investment and taxable income limits on Section 179 expense. For the Section 179 investment limit, every dollar invested in qualifying property over a certain dollar amount reduces the maximum annual allowable Section 179 amount. For the taxable income limit, a taxpayer may not claim more Section 179 expense than there is taxable income from the conduct of an active trade of business. Bonus Depreciation For tax reporting purposes, there may be an additional depreciation deduction allowed on qualifying property in the year it is placed in service. The deduction is 50% of the asset s unadjusted depreciable basis and, like the Section 179 deduction, it reduces the asset s basis on which other depreciation may then be claimed. This additional deduction is termed additional first-year depreciation or bonus depreciation. The rules governing bonus depreciation can be found in IRS Code Section 168(k). 12

13 Chapter 3 Reconciliation and Reporting Period and Year-End Close As part of the period or year-end close, depreciation is usually recorded, as well as any adjustments needed to reconcile the books. The net book value for assets at the end of the period should be the same in both the fixed assets system and the general ledger system. Once the books are closed, the corporate accountant can then reconcile and report on the following: Asset Balance Beginning Balance Period Additions Period Disposals Period Transfers Ending Balance Depreciation Balance Beginning Accumulated Depreciation Period Depreciation Expense Period Disposals Period Transfers Ending Accumulated Depreciation These items combined will allow for the calculation of the net property, plant, and equipment balance as: New Net PPE = Starting Net PPE + Asset Additions - Asset Disposals +/- Asset Adjustments - Accumulated Depreciation Calculating Gain or Loss on the Disposition of Assets To determine whether there is a gain or loss on the disposition of an asset, subtract the sale amount and accumulated depreciation from the original asset cost. A positive remaining amount means there was a loss on the sale of the asset. A negative remaining amount means there is a gain on the sale of the asset. 13

14 Chapter 3 Reconciliation and Reporting Here s an example: A company sells a piece of equipment for $10,000 The depreciable basis is $100,000 Its accumulated depreciation is $80,000 $100,000 ($80,000 + $10,000) = $10,000 loss on the sale The equipment s book value is $20,000 (the depreciable basis of $100,000 minus its accumulated depreciation of $80,000). Once the asset is sold, the $20,000 book value is removed from the accounts. In its place, the company received and records cash of $10,000. Since the company received $10,000 less than the amount it removed, it will report this as loss. The account that will be used to balance the debits and credits is called Gain on Disposition of Fixed Assets. Standard Reporting In any corporation, the accounting department bears the responsibility for accurately recording financial transactions and then reporting on the results of those transactions. Those reports help management answer questions and plan for the most appropriate course of action. Typical reports include: activity reports for asset acquisitions, disposals, and transfers; depreciation reports; projection reports; property tax reports; and consolidated reports for one business unit, multiple business units, or the entire enterprise. Financial Projections and Planning Financial planning is an essential part of any business regardless of the size of the company. When it comes to fixed assets, it s important to be able to analyze and report on the impact of future depreciation on the company s finances and answer questions such as: Should the company buy or lease a particular piece of equipment? Should the company invest in new plant capacity this year or wait until next year? With accurate fixed assets data, companies can create what-if scenarios that let them answer such questions. Some of these projections and what-if scenarios will require handling many variables such as multiple time periods, varying tax implications, and different depreciation rates. The ability to easily, quickly, and accurately create what-if scenarios for informed decision making is another reason why companies turn to fixed assets management software. Understanding what your options are for handling your fixed assets will ensure that you make the right decisions. For tax purposes, you want to take advantage of all available tax benefits that your fixed assets can provide to lower your tax liability as much as possible. For financial reporting, your fixed assets should be depreciated with the method that best matches each asset s depreciation expense with the asset s ability to provide income for the company, using an estimated life that best reflects each asset s true economic usefulness. 14

15 Chapter 4 Tracking and Controlling Asset Data The Importance of an Audit Trail An audit trail lets you trace financial data to its source and ensures good internal controls. For fixed assets, an audit trail means tracking all changes made to asset data at any point during the lifetime of an asset. An audit trail is a key component of compliance with mandates such as Sarbanes-Oxley. In fact, the audit trail requirement is one of the major reasons why businesses implement fixed assets management systems and it is a key element of a company s internal control documentation. A good fixed assets management system can automatically track changes made to an asset from acquisition date through the date of disposal while preserving the entire history of the asset. This includes scenarios such as the transfer of an asset between legal entities (or between different departments within the same company), splitting (and maybe partially disposing) an asset, and like-kind exchanges. Aside from the description of what was changed, your fixed assets management software should also track who made the change and when it was done. To assist you even further in managing your fixed assets, the software should inform you of the impact of the change on depreciation. Think about our earlier example of Company ABC (page 7) and how an adjustment needed to be made when the rebate on its air conditioning unit was received. If there was no audit trail, one might easily question why the asset s monthly depreciation expense suddenly decreased. However, with fixed assets management software, all Company ABC would need to do would be to run an asset changes report and instantly see that a rebate was received on the asset two months after it had been placed in service. Mystery solved and an audit question is answered. What are Internal Controls and Why are They so Important? There are two types of internal controls: preventive and detective. Preventive controls are, of course, preferable. Detective controls let you correct errors and mitigate the risk of having to reissue financial statements. An effective internal control system can detect, analyze, and correct any significant errors before they affect the financial statements. Consistently applied internal controls, augmented by a good audit trail, constitute what most companies strive for in order to most effectively manage risk. Protecting Your Data Another component of internal controls is protecting your fixed assets data. With accounting or fixed assets management software, you can control who is allowed access to the asset data when changes need to be made. In addition, a business should be able to run a report in order to verify whether each user s access is still appropriate based on the user s role. Knowing how often each user accesses the data can also be helpful. Good security is synonymous with good internal control. Companies also need to protect data once an 15

16 Chapter 4 Tracking and Controlling Asset Data accounting period has been closed and the financial statements have been issued. It is essential that your fixed assets management software indicates once a period is closed so that no one will inadvertently change the data. There is a balancing act between granting staff members access to the data, allowing edits to be easily made, and securing the data against incorrect entries. Policy Documentation This brings us to another important issue. When managing fixed assets, a company needs to control the depreciation policies that are applied to newly added assets. In order to avoid having inconsistent application of asset classifications and depreciation methods, companies should establish policies that govern how to define assets and determine the appropriate depreciation methods to be used. Let s say that, for tax purposes, Company ABC has a substantial amount of past net operating losses (NOLs) that are being carried forward and are about to expire. In such a scenario, the company may want to use slower depreciation methods or limit the use of bonus depreciation, for example, to reduce the amount of the annual depreciation expense, increasing taxable income to absorb the NOL. Depreciation policies, and particularly ones that can be automatically applied by software, can ensure that asset data is entered correctly the first time. For instance, if Company ABC has a new or temporary employee in its accounting department, having depreciation policies can help ensure assets are depreciated correctly for the maximum tax benefit. 16

17 Chapter 5 Fixed Assets Management Software distribution, human resources, and more. Unfortunately, it is difficult for corporate tax professionals to properly manage fixed assets and depreciation using the ERP system. The ERP system typically cannot support both GAAP depreciation and tax depreciation. Nor can most of these systems either provide the detail your fixed assets require or the comprehensive guidance and support necessary to stay compliant with the ever-changing rules and regulations. The Role of the General Ledger System The general ledger is the core of your company s financial records. It is the main accounting record of a business and includes accounts for items such as current assets, fixed assets, liabilities, revenues, expenses, gains, and losses. The balance sheet and the income statement are both derived from the general ledger. While the general ledger is considered the central book of your company, it s usually no longer an actual paper book. The general ledger is now the backbone of the accounting software package for the company. With respect to fixed assets, nearly every general ledger/accounting software vendor provides some fixed assets management capability within its application. Most however do not include all the tax and accounting capabilities needed for complete fixed assets management. The Role of the ERP System Built on a centralized database and normally utilizing a common computing platform, ERP (Enterprise Resource Planning) systems consolidate all business operations into a uniform and enterprise-wide environment. These systems cover financials such as general ledger, cash management, accounts payable, accounts receivable, and fixed assets, as well as Fixed Assets Management Software The challenge of fixed assets management, depreciation, and control is better suited to software specifically designed to handle the complex needs of this area of accounting. A robust, enterprise-class GAAP and tax depreciation system delivers the control, efficiency, comprehensive reporting, and visibility companies need to maximize their return on asset investment while reducing the manual effort and current inefficiencies involved in managing, depreciating, and tracking fixed assets. Specifically designed to support complex corporate requirements, a GAAP and tax depreciation system offers built-in tax and GAAP expertise and automatic updates to reflect any 17

18 Chapter 5 Fixed Assets Management Software changes. For example, a good fixed assets management system delivers: Validation that enforces compliance with tax regulations and GAAP rules Comprehensive financial reporting Tax-specific reporting An interface that contains tax-specific fields such as tax credits and expensing options Analysis and what-if capabilities Automatic application of policies Consolidation across divisions and companies Integration with the ERP, accounting, and tax compliance software being used by the organization A complete audit trail Selecting the right fixed assets management software can ensure compliance with myriad government and accounting regulations and simplify your life, reducing your fear of risk from potential errors and lost opportunities for claiming legitimate deductions. Plus, good software provides a reliable audit trail. However, to make the most of any software, you need to be an informed user. Fixed assets management software can provide all of the appropriate information but only you are sufficiently knowledgeable about your company to make the best decisions. Outstanding comprehensive software, when teamed with a knowledgeable user, is the best possible combination. A Word about Spreadsheets Keeping track of depreciation for each asset in the business can be an overwhelming task. It s tempting to use spreadsheets to track depreciation since many accounting systems don t offer the flexibility to maintain both GAAP and tax amounts. However, there are a number of risks and challenges inherent in using spreadsheets to handle depreciation. First and foremost is the lack of controls, as spreadsheets don t typically include security, audit trails, back-ups, quality control, documentation, and other capabilities found in enterprise software. Spreadsheets can also increase the risk of error, with 18

19 Chapter 5 Fixed Assets Management Software the chance of a mistake increasing exponentially as the level of complexity within the spreadsheet increases. Finally, using a spreadsheet to manage and track fixed assets usually results in an extremely complex spreadsheet, requiring a significant number of hours to maintain and validate its accuracy. Complex spreadsheets can put companies at major risk for faulty decision making, lack of compliance with tax regulations and GAAP rules, audit problems, fraud, the loss of historical data, and even the loss of the spreadsheet application itself. Providing an audit trail for changes to financial data is a major compliance issue for Sarbanes-Oxley. Secondary to the risk, but also vastly underestimated, is the productivity drain from maintaining complex spreadsheets. The creators of the spreadsheets may spend more time programming the spreadsheets than they do performing their principal job function, leaving little or no time for analysis of the resulting data. And if the person who created the spreadsheet should leave the organization, the ability to maintain the spreadsheet going forward could be compromised. Spreadsheet Risk Diagnostic Tool Answer each question about spreadsheet use in your organization to the best of your knowledge. Add the scores (number in parentheses by each answer) to get a total spreadsheet risk score. Spreadsheet Risk, Awareness, and Control excerpted from Spreadsheet Engineering Research Project, Tuck School of Business, Dartmouth College Kenneth R. Baker, Lynn Foster-Johnson, Barry Lawson, and Stephen G. Powell 1. How important are spreadsheets in your organization? Not at all important (1) Somewhat important (2) Important (3) Very important (4) 2. What is the size of the spreadsheet models generally created? under 100 cells (1) 101 to 1,000 cells (2) 1,001 to 10,000 cells (3) 10,001 to 100,000 cells (4) over 100,000 cells (5) 3. How many other users are there for a typical spreadsheet? None (1) 1 other person (2) 2-5 other people (3) 6-10 other people (4) More than 10 other people (5) 4. How often is a spreadsheet used after it is developed? Annually (1) Quarterly (2) Monthly (3) Once or twice a per week (4) Daily (5) 5. What are spreadsheets used for in your organization? (Check all that apply) Analyzing data (e.g., financial, operational) (1) Determining trends and making projections (1) Statistical analysis (1) Optimization (e.g., Solver, What s Best) (1) Simulation (e.g., Crystal (1) Total Score: The sum of the scores associated with the answers to the five questions yields a Total Risk Score for the company. Three categories of risk differentiate between those firms where the potential for spreadsheet risk is most likely low, and where risk is most likely high. CATEGORIES OF RISK 12 or below = Low Risk; = Medium Risk; 17 or above = High Risk 19

20 Chapter 6 Inventory Audit Best practices for tracking assets include: Conduct an accurate, detailed physical inventory and tag all assets with bar code or RFID (radio-frequency identification) tags Reconcile this field data with the accounting records to confirm assets found or missing Implement an asset tracking application to be maintained by line management that interfaces easily with the accounting system for capital assets Insist that newly acquired assets be tagged and relevant information recorded upon receipt Ensuring the Accuracy of Asset Information While fixed assets accounting focuses on the financial aspects of assets, including depreciation calculations and financial reporting, it is dependent upon having an accurate picture of actual physical inventory. Well-managed organizations perform regular fixed asset inventories and audits. In particular, public organizations are required to comprehensively count all fixed assets on an annual basis. The asset inventory process involves establishing an accurate basis and developing policies and procedures for maintaining and auditing this information going forward. Establishing a company-wide asset inventory policy that defines inventory frequency and identifies what types of assets must be inventoried is key to reducing costs, ensuring compliance, and establishing best practices for overall fixed assets management. Conducting a Physical Inventory Before you start the inventory validation process, ensure you have the software, hardware, and expert help you need to make it a success. Critical ingredients for asset inventory include: Organization-wide participation Individual asset tagging Automated data collection and maintenance Integration with your fixed assets or accounting system Asset labeling provides a foundation for rapid, accurate inventories. And because a bar code label is simply scanned, the person conducting the inventory does not need extensive product knowledge to create reliable results. Each asset will be affixed with a bar code label. During the process, 20

21 Chapter 6 Inventory Audit relevant asset data is collected and missing information such as location, condition, serial number, tag number, custodian, and cost center is entered. Reconciling with Accounting Records Once you have conducted a physical inventory, you will need to reconcile the results with your asset records. As part of the reconciliation, exceptions are identified as well as any ghost assets (i.e., assets that no longer physically exist, yet remain on the company s books) and zombie assets (i.e., assets that physically exist, but are not recorded). Best practices include matching, scanning, and attaching corresponding invoices to your asset records. Ongoing Asset Management and Control With an improved asset management process, companies can address both near-term compliance requirements and long-term process improvement to: Maximize the return on capital investment Increase efficiency of asset management, saving both time and money Improve the accuracy of both financial and tax reporting Demonstrate Sarbanes-Oxley compliance Performing asset inventory periodically (once every two or three years) is not only good practice for fixed assets management, but it will also potentially reduce your property taxes, income taxes, and insurance. Plus, it provides the documentation you need to validate that financial data on the books ties directly to assets on the floor. Asset Inventory Process Checklist Examine Existing Asset Data Are assets tagged? Are individual assets identified? Are capital and non-capital assets identified, if needed? Are there ghost assets? Is the data consistent? Is the data complete? Define the Scope: Asset Inventory Work Locations and assets to inventory Types of assets to include in the reconciliation capital or non-capital assets Assets with $X NBV or set a materiality threshold Tagging method Conduct the Asset Inventory Identify target assets based on scope of the project Fix each asset with bar code labels Collect relevant additional asset data (location, condition, serial #, tag #, custodian, cost center, etc.) Convert Existing Fixed Assets Data Export data to spreadsheet from fixed asset system such as BNA Fixed Assets for analysis (to fit scope) Include data for non-capitalized assets Import data into asset inventory system such as BNA Asset Inventory Perform Upload and Data Analysis Upload data from readers to the database Perform verification and data analysis Review all exceptions Commit verifiable data to the database Asset Inventory Data Reconciliation Capital or Non-capital assets Grouped assets must be identified individually Based on scope, reconcile with fixed assets data Match asset records/invoices with target assets Scan invoices and attach to asset records Split Group assets in FA product & add bar code number Identify ghost assets Record adjustment as required Maintain Asset Data in Asset Inventory Minimum: New additions Maximum: Every transaction/activity Periodic Audit Inventory Select asset/locations All locations Schedule cycle 21

22 Appendix Resources BNA Fixed Assets With BNA Fixed Assets, it s easy, efficient, and cost-effective for companies of any size to manage the complete fixed assets lifecycle from purchase to retirement saving you time and money while ensuring accuracy. Bloomberg BNA s renowned tax expertise is built right into the software it s like having a tax expert at your side, providing the most up-to-date, comprehensive insight into the latest accounting rules and regulations. Our unique validation engine enforces compliance with tax regulations and GAAP rules, automatically ensuring accuracy. Even novice users can correctly and easily use the software without compromising accuracy. BNA Fixed Assets delivers all the capabilities of a robust fixed assets management system and grows with you as your business matures. Whether your company has tens, hundreds, or thousands of fixed assets, there s a BNA Fixed Assets solution designed to meet your needs and budget: Desktop Designed for a single user, it s powerful, but easy to use Server For multiple users within the same company Web-hosted No software to install or maintain BNA Asset Inventory Integrated with BNA Fixed Assets, BNA Asset Inventory helps you track assets such as furniture, fixtures, IT software and hardware, plant assets, machinery, equipment, tools, and more from receipt of the asset through to retirement. Using bar codes, BNA Asset Inventory streamlines the management of all of your physical fixed assets, providing you with: More accurate asset inventory management Less effort and fewer errors by eliminating duplicate entry of assets Improved visibility into working and ghost assets, potentially reducing your property taxes and insurance Better internal controls for regulatory compliance With Bloomberg BNA s software products, you can efficiently perform accurate asset inventory, validate data and reconcile it with existing asset data on the books, and track the physical location of assets for accurate payment of personal property taxes and insurance payments just point and scan for accurate inventory tracking South Bell Street Arlington, VA Phone: Fax: Web: BNA Software, a division of Tax Management Inc. All rights reserved. 22