Journal entry for purchase of fixed asset on credit
Introduction
In business, the company may need to purchase the fixed asset on credit to use in day-to-day operations. Likewise, the company needs to make the journal entry for the purchase of the fixed asset on credit in order to account for the new capitalization of the cost of the fixed asset as well as to account for the liability that exists at the time of the purchase.
Later, when the company makes the cash payment for this purchase of the fixed asset, it can make another journal entry to record the cash payment and to eliminate the liability that it has recorded previously. This is when the company fulfills its payment obligation that exists when it has made the credit purchase of the fixed asset.
Of course, if the company makes the purchase of the fixed asset in cash, there won’t be any liability involved there and it will just need to record the capitalized cost of the fixed asset with the reduction of the cash balance instead. In any case, the capitalization cost of the fixed asset includes all costs necessary to bring the asset to its usable condition, in which they may include sales taxes, delivery cost, installation and testing cost, etc.
Additionally, as the cost of the fixed asset will be depreciation from the day that it is ready to use, the company will also need to make the depreciation journal entry for the purchased fixed asset at end of the accounting period. This depreciation of the fixed asset is necessary to spread the cost of the purchased asset over the accounting periods that such asset provides benefits to the business.
Journal entry for purchase of fixed asset on credit
The company can make the journal entry for the purchase of fixed asset on credit by debiting the fixed asset account with the capitalization cost of the purchased fixed asset and crediting the accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Fixed asset | 000 | |
| Accounts payable | 000 |
This journal entry will increase the total non-current assets as a result of the capitalization of the new fixed asset on the balance sheet. At the same time, it will also increase the total liabilities on the balance sheet as a result of the purchase of fixed asset on the credit.
Later, when the company makes the cash payment for the credit purchase of the fixed asset that it has made previously, it can make the journal entry for the payment of the fixed asset purchase on credit by debiting the accounts payable and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 000 | |
| Cash | 000 |
This journal entry will eliminate the accounts payable that the company has recorded for the credit purchase above.
Then, at the end of the accounting period, the company needs to record the depreciation of the fixed asset in order to allocate the cost of the purchased fixed asset to the period it provides benefits to the business. In this case, the company can make the journal entry for the depreciation of the purchased fixed asset with the debit of the depreciation expense account and credit of the accumulated depreciation account.
| Account | Debit | Credit |
|---|---|---|
| Depreciation expense | 000 | |
| Accumulated depreciation | 000 |
This journal entry will charge the depreciation amount to the income statement as a depreciation expense while reducing the net book value of the fixed asset with the amount of the accumulated depreciation. Likewise, this journal entry will increase total expenses on the income statement and decrease total assets on the balance sheet.
Example of purchase of fixed asset on credit
For example, on January 1, the company ABC purchases new office equipment that costs $50,000 on credit from one of its vendors. The company ABC receives the office equipment and it is ready to use on the same day of the purchase.
On February 1, the company ABC make this $50,000 payment to its vendor to settle the credit purchase of the fixed asset that it made on January 1. This $50,000 office equipment is expected to have a useful life of 10 years. And the company ABC use the straight-line depreciation method for all of its equipment type of fixed asset.
In this case, the company ABC can make the journal entry for the credit purchase of the $50,000 office equipment by debiting this $50,000 amount to the equipment account and crediting the same amount to the accounts payable as below:
| Account | Debit | Credit |
|---|---|---|
| Equipment | 50,000 | |
| Accounts payable | 50,000 |
This journal entry for the credit purchase of the fixed asset, which is the $50,000 office equipment, will increase both total assets and total liabilities on the balance sheet by $50,000 as of January 1.
Later, on February 1, when the company ABC makes the cash payment of $50,000 to its vendor for the credit purchase of this $50,000 office equipment, it can make the journal entry to settle the payable as below:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 50,000 | |
| Cash | 50,000 |
This journal entry will clear the $50,000 accounts payable that the company ABC has recorded on January 1 as a result of the credit purchase of a fixed asset. At the same time, there will be a cash outflow of $50,000 on February 1 that will be shown on the cash flow statement as an investing activity.
Then, at the end of the year, the company ABC can make the journal entry for depreciation of the equipment with the amount of $5,000 ($50,000 / 10 years) as a yearly depreciation as below:
| Account | Debit | Credit |
|---|---|---|
| Depreciation expense | 5,000 | |
| Accumulated depreciation – equipment | 5,000 |
This journal entry of the $5,000 depreciation of the fixed asset will increase the total expenses on the income statement by $5,000 while decreasing the total assets on the balance sheet by the same amount at the end of the year.
Purchase of fixed asset in cash
Alternatively, if the company makes the purchase of the fixed asset in cash, it will need to record the capitalized cost of the purchased asset on the balance sheet while reducing the cash balance accordingly. This transaction will immediately result in the cash outflow from the business by the amount that the company pays for the purchase of the fixed asset.
In this case, the company can make the journal entry for the purchase of the fixed asset in cash by debiting the fixed asset account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Fixed asset | 000 | |
| Cash | 000 |
In this journal entry, there will be no impact on the total assets on the balance sheet as the increase in the fixed asset balance will offset the decrease in the cash balance. However, there will be an impact on the statement of cash flow, in which the reduction of the cash as a result of the purchase of the fixed asset here will be shown as an investing activity in the statement of cash flow.
For example, assuming that the company ABC in the example above makes the purchase of the $50,000 office equipment in cash instead of purchasing it on credit. If this is the case, the company ABC will need to recognize the purchase of the fixed asset in cash by recording the cash outflow from the company immediately.
Likewise, the company ABC will need to make the journal entry for the purchase of the $50,000 office equipment by debiting this amount to the equipment account and crediting the same amount to the cash account for the result of the cash outflow from the business.
| Account | Debit | Credit |
|---|---|---|
| Equipment | 50,000 | |
| Cash | 50,000 |
After this journal entry, the total non-current assets on the balance sheet will increase by $50,000 while the total cash balance will decrease by the same amount of $50,000.