Every time you purchase an asset, you’re investing in the future of your business, but the value of equipment and assets tends to reduce over time – a process known as depreciation. It’s important you calculate and track this depreciation accurately.

There are many benefits to this, a major one being that it will help you understand where your business loses value each year. We’ll look at depreciation, what it is, and where it goes in your accounts.
 

What is depreciation?

What is an asset?

Are there different types of depreciation?

Where is my depreciation tracked?

What is the depreciation on my income statement?

What is the depreciation on my balance sheet?

Something depreciating simply means it loses value over time. For example, you buy your staff an iPhone each so they can make company calls. With ‘wear and tear,’ and new models constantly coming to market, it’ll lose its value over time and eventually drop to £0 (or in most cases, until it no longer works, or you purchase a new model).

You’ll use depreciation on any long-term tangible assets when you work out your company’s tax relief.

In short, an asset is anything your business owns or controls. It often holds value in your business, such as computers for your employees to get their work done. Assets have economic value and will either generate cash, improve sales, or reduce expenses.

There are two ways you can calculate depreciation on your capital assets:

• Straight-line depreciation
• Reducing balance depreciation

This is tricky – and not something anyone expects you to do alone! You can use software (just like Pandle) to record your assets and adjust their depreciation.

Straight-line depreciation

This is where you take the value of an asset and divide it by the number of years you estimate it to be in use.

Let’s say you bought equipment worth £2,000. If you believe it’ll be around for about 5 years, you’ll divide £2,000 by 5. That will equal £400, so you’ll add this cost each year onto your profit and loss account.

Reducing balance depreciation

This one can be a bit more complex, used for assets that tend to have a higher value at the start of their life.

For instance, you buy a member of staff the latest iPhone, worth £1,200. You estimate it’ll last for 2 years and depreciate 30% each year.

Your first year’s calculation would be:

• 30% of £1,200 = £360

This means the accumulated depreciation is £360 and the asset’s value at the end of the first year is now £840. You’ll then repeat this again, for each year you own the asset.

So, 30% of £840 is £242 (that’ll be £602 depreciation accumulated when you add 360+242) and the new asset total would be £598.

So, there are two things you need to track. Your depreciation expense, and your total accumulated depreciation.

• Depreciation expense is the amount your company assets have depreciated in one specific period – for example in a year or quarter.
• Depreciation accumulated is the total amount of depreciation of all your company’s assets.

You’ll report depreciation expenses like any other normal expenses within your income statement, whereas accumulated depreciation is the total depreciation expenses and is reported on your balance sheet.

Depreciation expenses, known as a ‘non-cash’ charge, are listed as business expenses on your income statement. This is because you’ll record a ‘net cash outflow’ of the assets’ total value when you initially purchase it.

Your net cash outflow is any money leaving the business. A different example of this would be employee’s salaries or maintenance costs for your business premises.
 

How to record depreciation on your income statement:

• Decide whether you’re going to record it with just one journal entry for all your fixed assets, or have different entries for each fixed asset category
• Record a debit in the depreciation expense account
• You’ll now need to ‘balance’ your entry by recording the same amount as a ‘contra account’ within your balance sheet to decrease the fixed asset’s value. (In your balance sheet, accumulated depreciation is a contra account, meaning its balance is a credit which will reduce the overall value of the asset.)
• Once your accumulated depreciation amount has reached the cost you paid for your fixed asset, the value is zero – so it’s now time to stop recording depreciation expenses for that specific asset!

The amount of depreciation will be for the period you’re reporting and not the accumulated amount. Accumulated depreciation is reported as a contra account on your balance sheet!

Accumulated depreciation is the total amount of depreciation against all your fixed assets, and is reported on your balance sheet as a ‘contra account’ which reduces the overall value of an asset.
 
Need help with depreciation? Learn more about how Pandle can help you and create your free account today.

Rachael Johnston

A creative content writer specialising across business, finance and software topics. I have a love for all things writing, and creating engaging, easy to understand content that helps everyday people!