The value of the company assets like machinery, computers, and office furniture diminishes with time. Depreciation is an accounting term, which means as an asset moves through its productive life, its value gradually decreases from the original price. This blog will inform you about what is depreciation, how to work out depreciation, and why it should be important to you as an owner of a business. So, let’s start!
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What is Depreciation?
Depreciation is the process by which the value of your company’s assets decreases over time. As a result, depreciation affects the book value of your assets on the balance sheet. When an asset depreciates, you won’t be able to sell it for the original price. Moreover, because the business uses its value for sales and profit, depreciation is considered a day-to-day operating expenditure on the profit and loss sheet. A computer, for example, depreciates over time and eventually becomes unusable, reducing its original price to zero.
What are Depreciable Assets?
Depreciable assets are tangible assets that gradually deteriorate, decrease in value, or become useless over time by use and wear and tear. The term used for the diminishing value of intangible assets is known as amortization. Fixed assets are classified into two categories:
Tangible (Fixed Assets) – The assets that can be touched are tangible assets such as buildings, machinery, computers, cars, desks, etc.
Intangible (Fixed Assets) – The assets that can not be touched are intangible assets such as Intellectual property, goodwill, software, copyright trademarks, patents, etc.
How Does Depreciation Apply in Accounting?
Depreciation is a non-cash cost. It is categorised in the two following perspectives:
- Income Statement – The decrease in the original value of an asset is treated as an expense.
- Balance Sheet – Same as in the income statement, depreciation affects the book value of your assets.
How to work out Depreciation in the UK?
You need to calculate depreciation to see how an asset’s value depreciates over time and how quickly this happens. There are many methods for calculating depreciation in the United Kingdom, such as:
1) Straight Line Method
According to this method, the value of assets depreciates at the same rate every year until they become obsolete (useless). An asset with a three-year lifespan, for example, would lose one-third of its value each year. The formula of this method is as follows:
Depreciation = Purchase Cost of Fixed Asset / Useful Life of Fixed Asset
2) Diminishing Value Depreciation
The asset depreciates at a higher rate in the first few years under this method. And, over time, the rate of depreciation decreases. This formula can be used to compute depreciation using this method:
Depreciation= Purchase Cost of Fixed Assets * Reducing Balance Percentage / Projected Lifespan In Years
3) Units of Production Depreciation
Some products have a longer lifespan when measured in terms of their work rather than their time. An automobile, for example, may operate for certain miles, or a packing machine may pack a given number of products. Therefore, rather than being depreciable based on their age, these assets are depreciable based on their functioning capabilities.
Depreciation= (Cost – Residual/Salvage Value) * (Number Of Units Produced / Life In A Number Of Units)
Depreciation for Small Businesses
Depreciation will help you better understand your expenses and lower your tax bill ( which are positive outcomes). At first, it will appear to be complicated, but there’s not too much to worry about. Many businesses consider the schedule of depreciation, which is provided by HM Revenue & Customs. Once the depreciation is set in the accounting application (software), the calculation is performed automatically. An accountant or bookkeeper, as usual, can help you along the route.
We hope now you understand the basic information of what is depreciation, depreciable assets, how depreciation applies in accounting, and how to work out depreciation in the UK. This information will assist you in better understanding the worth of your assets, lower your tax burden, and increase your company’s value. Moreover, suppose you don’t want to work out manually. In that case, you can use your accounting software to implement HM Revenue & Custom’s depreciation schedule and submit accurate data immediately to your tax return.
Disclaimer: This blog contains general information about depreciation.