Whether you operate as a large corporation or a small start-up, depreciation is an incredible tool to ensure that valuations of your business, both internally and externally, are representative of the entire operations of the business. This is helpful for when seeking funding from venture capitalists, or even when running finances within the organisation.
The process of depreciation occurs when the value of an asset decreases over time. As a result, businesses must determine whether the overall value of an asset is worth the cost to the business. This can be done by allocating the original price of the asset over the period of time that the asset is used. An example of this happening in the workplace may include the cost of machinery, the value gradually depreciates from its original cost down to $0 as it continues to operate.
There are several techniques to measure the decline in the value of assets and auditing these costs. Some techniques can get extremely complex, so it is recommended to work with a professional, or use detailed templates such as Business Kitz’ Bookkeeping and Accounting Kit.
Depreciation is essential for businesses to help determine the cost of an asset compared to the benefit of its use over time. It is hoped that the expense recognition for an asset matches the revenue generated by that asset. The ‘matching principle’ is where revenues and expenses both appear in the income statement in the same reporting period, giving the best view of how well a company has performed in a given reporting period.
Ultimately depreciation can create a significant expense to a business as there becomes a repetitive need to replace assets if they have been used extensively. The overall loss of value should therefore be calculated throughout the year to list the company's profit and loss statement, and subtract from revenue when calculating profit. Without the calculation of depreciation, a company would not be able to accurately estimate its costs, resulting in a false revenue prediction.
Without the integration of depreciation within a businesses financial analysis, the business will pay too much tax.
When it comes to valuing your business, the loss in value of an asset results in loss in value of a business. It is important to list assets from your balance sheet on a ‘fixed asset register’, which can be updated once the depreciation is calculated.
Straight line depreciation splits an asset’s value equally over multiple years, meaning costs remain the same for every year of the asset’s life. This is valuable for small businesses who use simple accounting systems or businesses where the business owner prepares and files the tax return.
Formula = (Cost of asset – Salvage value of asset) / Useful life of asset = Depreciation expense.
Double declining depreciation allows you to write off more of an asset’s value right after you purchase it and less as time goes by.
Formula = 2 x (single-line depreciation rate) x (book value at beginning of the year) or use a double declining calculator.
This depreciation method is used instead of decreasing book value. Sum of the years (SYD) is a calculated weighted percentage based on the asset’s remaining years of use.
Formula = (Remaining lifespan / SYD) x (Asset cost – Salvage value)
This type of depreciation is used when the value of an asset is based on how frequently the asset is used. This method refers to something the equipment makes and the quantifiable value it delivers e.g. how many trips a company car can offer.
Formula = (Asset cost – Salvage value) / Units produced in useful life
A fixed asset is classified as something that will assist in generating income for more than a year. Intangible assets including patents and copyrights can be depreciated as the value gradually decreases as they near expiry. Tangible assets include items such as:
There are some assets that a business may hold that cannot be depreciated. This is due to the fact that they may not lose value over time, and therefore do not accumulate cost to the business.
A fixed asset is classified as something that will assist in generating income for more than a year. This may include tangible assets such as tools, computers, machinery, vehicles etc. These may also include leased items. Intangible assets including patents and copyrights can also be depreciated as the value gradually decreases as they near expiry.
If you are unsure about how to best protect your business when it comes to depreciation and following tax obligations, our company, Legal Kitz can assist you. To arrange a FREE consultation with one of their highly experienced solicitors, click here today, or contact us at info@legalkitz.com.au or 1300 988 954.