Depreciation and Why it is Important to Business

Depreciation and Why it is Important to Business

When running a business there are several things we need to consider, depreciation being one of them. Depreciation is where a business’s assets over time, lose value.

The property, plant and equipment, otherwise known as: PP&E, are fixed assets bought and used over a period of time to help your business produce income. Depreciation is where the cost of those assets are spread over their “useful life”, and the idea is to match those expenses to income.

Further, depreciation accounting helps you truly understand and calculate the value and cost of your business. To help maximise profit and revenue as well as reduce your tax bill.

What are the three functions of depreciation?

There are three functions of depreciation you need to understand in relation to your business. These include, Depreciation and Tax, Depreciation as an Expense and Valuing your Business. There are also a range of ways you can calculate depreciation. In other words, calculate how you can spread the cost of each asset over its “useful life”. Remember, tax and accounting rules set out what “useful life” an asset has and is the foundation of how you can calculate the depreciation. Further, an accountant can tell you the best method to use in relation to your fixed assets.

Depreciation and Tax

Due to depreciation lowering business profit, it can be used in some cases to lower your tax bill. There are rules on how quickly you can depreciate an asset, however you can slowly claim the value of an asset, off your tax.

Depreciation as an Expense

Depreciation is considered a cost in a business. This is because the fixed assets bought, eventually need to be replaced after a period of time. Further, depreciation is useful, because it allows you to understand how much value your assets lose over the year.

To work this out, using your annual profit and loss report, the depreciating value needs to be recorded and then subtracted from the revenue made.

Valuing your Business

Assets have enormous influence on calculating business worth. For example, when your assets drop in value, so can your business. If you own a computer company for example, yet you use older computer models, you may not be as desirable as a computer company with newer models.

Every asset should be recorded on your balance sheet and it is paramount you update the balance sheet every time you work out your depreciation.

Did you know assets have influence on taking out loans also? If your assets are older, it may be more difficult to secure loans. This is because declining value in an asset offers less loan security.

Methods of Calculation
  1. The Straight-Line Method
  2. Declining Balance
  3. Units of Production

There are three main methods of calculating depreciation.

The straight-line method is when the asset depreciates the same amount every year.

The declining balance method is best used for assets that quickly lose their value overtime. A faster method of depreciation will suitably match how such assets are used, if they are phased out for newer assets in only a few years.

The units of production method is measured by the wear and tear of the machinery as a direct result of the number of units that machinery is expected to produce over its useful life.

We hope this helps you understand depreciation in terms with owning your own business.

Depreciation can be overwhelming, but don’t stress because Aspect Accountants and Advisors will be able to help!

If you are looking for Accounting Advice in West Perth, Aspect Accountants and Advisors can help. Click here to contact us or call us on 9227 9400