What Is a Physical Asset?
A physical asset is an item of economic, commercial, or exchange value that has a material existence. Physical assets are also known as tangible assets. For most businesses, physical assets usually refer to properties, equipment, and inventory.
Physical assets are the opposite of intangible assets, which include such things as brand names, patents, trademarks, leases, computer programs, customer lists, franchise agreements, domain names or trade secrets.
Understanding Physical Assets
A business's core operations are centered around its assets which is recorded on the balance sheet. Assets equal the sum of a company’s total liabilities and its shareholders’ equity. The main form of assets in most industries are physical assets.
Physical (tangible) assets are real items of value that are used to generate revenue for a company. Physical assets are either current or fixed. Current assets include items such as cash, inventory, and marketable securities. These items are typically used within a year and can thus be more readily sold to raise cash for emergencies. Fixed assets, on the other hand, are noncurrent assets which a company uses in its business operations for more than a year. They are recorded on the balance sheet under the property, plant, and equipment (PP&E) category and include assets such as trucks, machinery, office furniture, and buildings. The money that a company generates using physical assets is recorded on the income statement as revenue.
Usually, physical assets refer to things that may be liquidated in the event of default in order to pay off debts. Physical assets belonging to a restaurant company, for example, would include chairs, tables, refrigerators, and food. Although some physical assets can be inventoried or stored, they may be diminished through depletion, depreciation, deterioration, or shrinkage in the storage process.
Physical assets also differ from financial assets. Financial assets include stocks, bonds, and cash, and though they may fluctuate in value, unlike physical assets, they do not depreciate over time.
- Physical assets, also known as tangible assets, are items of value that have a real material presence.
- Physical assets include things like property, plant, and equipment as well as inventories.
- Physical assets are recorded as either fixed or current, where depreciation and impairment may alter their accounting treatment.
Accounting for Physical Assets
Physical current assets are recorded at the cost incurred to acquire them. The cost of an asset is usually available on the bill or invoice received from the seller. If the firm purchased inventory for $200,000, this is what will be shown on the financial statement. The cost for physical fixed assets may include transportation costs, installation costs, and insurance costs related to the purchased asset. If a firm purchased machinery for $500,000 and incurred transportation expenses of $10,000 and installation costs of $7,500, the cost of the machinery will be recognized at $517,500.
Physical fixed assets receive special treatment for accounting purposes since they have an anticipated useful life of more than one year. A company uses a process called depreciation to allocate part of the asset's expense to each year of its useful life, instead of allocating the entire expense to the year in which the asset is purchased. This means that each year that the equipment or machinery is put to use, the cost associated with using up the asset over time is recorded.
In effect, tangible fixed assets lose value as they age. The rate at which a company chooses to depreciate its assets may result in a book value that differs from the current market value of the assets. Depreciation is recorded as an expense on the income statement.
Physical assets can also be impaired due to damage or obsolescence. When an asset is impaired, its fair value decreases which will lead to an adjustment of book value on the balance sheet. A loss will also be recognized on the income statement. If the carrying amount exceeds the recoverable amount, an impairment expense amounting to the difference is recognized in the period. If the carrying amount is less than the recoverable amount, no impairment is recognized. A physical asset that is fixed may be disposed of or sold at the end of its useful life for a salvage value, which is the estimated value of the asset if it was sold in parts.