What Is Depreciation?
If an asset is in use for more than a year, it tends to lose value. To offset this declining amount or value with its cost, one can depreciate the expense. Depreciation is an income tax deduction by claiming it in the form of a tax return.
Short definition of Depreciation: “Reduction in the value/worth of an asset over the time period” (also can be due to wear and tear).
The process of deducting the asset’s cost in certain business expenses is done in parts over time without doing it in one tax year. Writing this off in claims every year gives more control over the finances for anyone. Depreciation is considered an expense, and it enters the accounting books. But as it is a non-cash expense, it will not affect the cash flow in a business. Some things lead to depreciation while accounting, and with good knowledge, a person will be able to determine the depreciation value with time. Different assets sort into different classes with varying depreciation policies. Self-owned properties that are useful to the business or developing the income but prone to depreciation are:
- Office furniture
- Workplace equipment
How To Calculate Depreciation?
In order to calculate the depreciation expense in different ways and methods for each type, there are some popular formulas. They are:
- Straight-line depreciation method
This is the simplest way to calculate depreciation for a fixed asset by using the straight-line procedure. This is ideal for small businesses that need business grants for women who own simple accounting systems without an accountant or tax advisor. This method splits the value evenly throughout the lifetime of the asset. Here the cost of the asset is subtracted with the salvage value and then divided with the total life span of the property. The value is the amount to be deducted every year.
Depreciation = (Asset cost – Salvage value)/ Total Life
- Double-declining balance depreciation method
This is a complicated way to determine the depreciation value and needs external support or expert advice. It is for businesses that want to recover more from an asset value upfront. It lets one write off more of the asset value in the beginning days and less later on. In order to calculate the depreciation value, the double of straight-line depreciation rate multiplies with the asset’s book value without considering the original cost of the property.
Formula: Depreciation = (2 * straight-line depreciation rate) * (book value at the beginning of the year)
- Sum of the year’s digits depreciation
It is a method again for businesses that want to recover the asset’s value upfront but with an even distribution. This helps to find the depreciation of the asset cost in the early years of its life span and less in the later years. It is determined by dividing the asset’s remaining lifetime with the sum of the year’s digits of depreciation and then multiplying with the value to write off for the year.
Depreciation = (remaining life span/SYD) * (asset cost – salvage value)
The tangible and long-term properties that are in use in a business operation are prone to depreciation. It must essentially be a physical object and must last more than a year in the business for it to get depreciated. Land is one asset that cannot depreciate as it does not wear off and lose any value with time. Inventories are the following non-depreciable items, as one can sell them off for revenue. Another essential thing to know is that leased property is one more thing that cannot depreciate.