Table of contents
Table of contents
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.
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:
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.
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.
This one can be a bit more complex, used for assets that tend to have a higher value at the start of their life.
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.
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.
To recap, depreciation expenses are recorded like any other business expense.
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.
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