A healthy business will buy assets over time for use within the business. Things like computers, equipment, and vehicles — the fixed assets of your business.
But through regular use, and everyday wear and tear, these assets lose the value they once had. It doesn’t mean they stop working, it just means effective re-sale value is less.
While you might not want to think about your car losing value, as a business this depreciation actually works in your favour.
Contact a Liston Newton Advisory depreciation specialist today to discuss how depreciation can benefit your business.
What is depreciation in accounting?
Depreciation in accounting is the act of a fixed asset losing value over time.
So, for example, an asset like a work vehicle, or new computer, will gradually depreciate from its original price as it ages.
Determining the depreciation in value of your business’s assets allows you to get an accurate figure of the true value of your business as a whole.
What can be depreciated?
Depreciating assets can include items like:
- Plant and machinery
- Vehicles, tools, and equipment
- Technology for your business
- Office furniture and business-related fittings
- Business property
- Investment property
Your accountant can advise you on the specific assets your business owns that can be depreciated.
Fixed assets explained
A fixed asset is an asset within your business that enables you to generate income over a period longer than a year, that loses value as it ages. This includes things like your computer, equipment, tools, machinery, vehicles, buildings, and furniture. Even leased items can be included on this list.
You can also include intangible items, so things like copyrights or patents, that are important to your business, but still lose value as they age.
If the asset doesn’t lose value, so for example your business owns land, this isn’t depreciated. Consumable items, like inventory or stationary, don’t depreciate either, as they’re consumable items that are used within the year of purchase.
Wear and tear: the cost of doing business
In its simplest form, depreciation can be considered as the cost of doing business. It’s an expense, as all your assets age and will eventually need to be replaced.
Depreciation in accounting allows you to determine a yearly figure that your fixed assets lose from their original purchase price. Add this figure to your profit and loss sheet, subtracting it from your revenue, and this allows you to calculate your overall profits.
If you fail to account for asset depreciation you may end up underestimating your business costs, making you think that your business is generating more profits than you actually are.
When calculated correctly, depreciation reduces your business profits, which works to lower your taxable income. Failing to take your deprecation into account means you may end up paying more tax than necessary.
Depreciation in tax accounting means that over time you’re able to claim the entire value of a business asset off your taxable income. This essentially provides a way to recuperate the asset’s purchase cost. Your accountant can advise on how to correctly calculate this value.
Depreciation for your business
As your business assets age, they lose value, which mean your business loses value too.
Take the example of a lawnmowing business. As the business progresses, their lawnmowers, trailers, and vehicles age, which means they aren’t worth as much as brand new equipment and vehicles. Therefore, a business using ageing assets like this isn’t worth as much as a business using new assets.
These assets will be listed on your business’ fixed asset register.
How to calculate depreciation in accounting
- Estimate the lifespan of the asset. The ATO provides a depreciation schedule for common small business assets
- Determine how your asset will depreciate.
- If it’s likely to depreciate at the same rate each year, this is known as straight line depreciation.
- If it loses a higher proportion of its value in its first few years, with the rate slowing as it ages, this is known as diminishing value depreciation.
- If the asset’s lifespan is measure by the work it undertakes—for example, a kilometres on a vehicle, or units produced by a machine—this is known as units of production depreciation.
- Use these two metrics to measure the asset’s decline in value over its lifetime.
Your business purchases a piece of equipment worth $10,000. Its expected lifetime is five years, and at the end of its life its value is considered to be $2,000, 20% of the original price. This final figure is known as its salvageable value.
Based on this, we can conclude that the equipment loses $8,000 of value in five years. Divided between five years, this equates to $1,600 depreciation each year.
These calculations will change depending on the asset's type of depreciation. Your accountant can advise on which is the appropriate measure.
Utilising the Instant Asset Write-off scheme
Businesses with a turnover of less than $50 million are able to write off the full amount of an asset that costs less than $30,000. They’re able to deduct the full cost of this purchase in its first year. If you choose this option, you can't claim depreciation on that asset.
Now, this asset doesn’t have to be brand new — it just has to be new to your business.
So essentially, purchasing these necessary business assets up to $30,00 decreases your taxable income by the same amount.
At present, there is no limit to the number of assets on which you can claim the deduction.
Over $30,000? Use your general small business pool
For depreciating assets that cost more than the instant asset write-off threshold, small business owners can choose to allocate these assets to their general small business pool.
Instead of calculating the effective life of the asset, each asset in the pool is depreciated at a rate of 15% in the year of allocation and 30% in other income years. This works on a diminishing value basis, irrespective of the effective life of the asset.
Financial records you'll need
To ensure your ability to claim tax on depreciation, it’s crucial to have all the necessary financial records available. You need to be able to provide:
- Proof of purchase of your fixed assets
- Amount of claimed in depreciation
- The adjusted tax value of each asset
- A tax-compliant invoice
The final word
It’s important to understand how depreciation works in order to take full advantage of the tax benefits available to you.
To get a full understanding of how depreciation can benefit your business, give Liston Newton Advisory a call today. With over 40 years’ experience in the industry, our tax accountants can provide guidance and support on how depreciation in accounting can work in your business’ favour.