Understanding depreciable assets is essential for effective financial management, tax compliance, long-term asset management, and making informed investment decisions that enhance the financial wellbeing of your business.
This article aims to provide a non-accountants explanation on what depreciation is, why it is so important and how it works. We hope Depreciation becomes your new favourite, fun, subject alongside re-reading the fascinating article Understanding Your Financial Statements.
Disclaimer: This article is by no means a comprehensive guide to all things Assets, Depreciation and Amortisation. When in doubt, seeking professional advice is the best advice we can offer. Your tax advisor (not us) is the first place to start.
Just a few of the terms used when discussing assets and depreciation are included below to illustrate just how complex the subject is.
Who else needs to know?
The Australian Accounting Standards Board sets out the guide to all things asset related in terms of how companies need account for them and present them in Financial Statements. The Corporations Act 2001 lays down the law to ensure companies present a true and fair view of their Financial Position. Our friends at the Australian Taxation Office also have a lot that must be listened to (and abided by) on the subject of assets and depreciation in particular, in relation to claiming deductions from assessable income so the correct amount of tax payable (or not) can be calculated.
What can be depreciated?
Depreciable assets of course! These are special types of capital assets that are controlled by businesses who use them in operations to generate income. We at T3 Partners tend to call them “Fixed Assets” in Xero and QuickBooks Online and Reckon but other types of assets can be depreciated as well. These assets will lose value over time due to wear and tear, age, or obsolescence. They are always non-current assets and can be either tangible and intangible. Note: Intangible assets are “Amortised” rather than “Depreciated”.
Examples of Capital Assets that may be able to be Depreciated or Amortised
Depreciation | Amortisation | |
Tangible |
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Intangible |
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What is Depreciation (or Amortisation)?
Generally you can claim a tax deduction for expenses incurred while earning business income, in the year of expenditure. However, costs related to acquiring capital assets are typically not deductible in the year the business started using them. You may, though, be able to claim deductions for the depreciation in value of these assets used in generating assessable income. Note: Depreciation is known as “Amortisation” in relation to intangible assets AASB138.
Depreciation is a fundamental accounting concept that reflects the gradual decrease in value of tangible assets over time.
Amortisation is the systematic allocation of the cost of intangible assets over their estimated useful lives. It applies to intangible assets such as patents, copyrights, trademarks, and licenses.
Why is Depreciation Important?
Depreciation serves multiple critical purposes for businesses:
1.) Accurate Financial Reporting: It allows for a true representation of the asset’s value on the balance sheet, reflecting its decline in value over time. It also allows businesses to spread the cost of an asset over its useful life, aligning the expense with the revenue generated by using the asset. This better reflects the actual financial performance of the business in any given period.
2.) Tax Deductions: It provides tax benefits by enabling businesses to spread the cost of an asset over its useful life, thereby reducing taxable income.
3.) Cash Flow Management: By accounting for depreciation, businesses can better manage their cash flow, ensuring they allocate appropriate funds for future capital expenditures and asset replacements whilst maintaining operational efficiency.
4.) Investment Decision-Making: Understanding the depreciation of assets aids businesses in making informed decisions about investing in new assets or replacing old ones as part of the Budgeting and Planning process.
a). Asset Valuation: Regularly accounting for depreciation provides more accurate valuation of assets on the balance sheet. This helps in understanding the true worth of assets and can assist in making informed investment decisions.
b.) Investment Analysis: Depreciation affects financial ratios used by investors and analysts to assess the profitability and financial health of a business. It can impact return on investment (ROI) calculations and other key performance metrics.
5.) Regulatory Compliance: Depreciation is often required by accounting standards and regulations, ensuring consistency and transparency in financial reporting.
Depreciation methods.
There are two main methods of Depreciation:
1. Straight Line (Prime-Cost in ATO speak): the business claims a deduction in equal portions for each year of the effective life of the asset. This is the method most often applied to calculating the amortisation schedules for intangible assets.
2. Decline in Value. A percentage is used which results a higher amount being claimed as a deduction in the early years of the asset, gradually declining over the latter years of the assets effective life.
Other Fun Facts
Depreciation, done right, may be a tax deduction!
Depending on the life choices and methods applied some assets will reach their end of life before others.
Determining the “effective life” of assets can be a choice. In some circumstances, the business owner can “self-assess” how long an asset will be useful in producing income. A business who does not wish to self-assess can simply use the Commissioner of Taxation’s determination. Which is best is best left to the experts – the business owner under guidance from their tax advisor.
Depreciation methods may also be chosen. “Book” or “Accounting” depreciation is chosen for the purpose of accurately representing the financial position of a business including the Accounting Depreciation Schedule. Best advice we can provide is: listen to your tax advisor!
The most important rule is to be consistent in the application of methods for determining effective life of assets and depreciation methods. Switching lanes half way through the race may not be possible and should be guided by your tax advisor.
Some industries have special rules around depreciation, for example Primary Industry businesses can access special rules and concessions like accelerated depreciation for some asset types.
Not for Profits are special too, there are different rules that apply to them depending on tax concessions they are eligible for.
Small business may be able to access their own simplified depreciation rules and have a “small business pool” to play in.
Other businesses that are not eligible for a simple life may still be able to access other types of “pools” under the general depreciation rules.
Using “pools” means using the decline-in-value depreciation method, no straight lines allowed!
There are limits to how much of the initial cost of some assets can be treated as a depreciable asset for example certain vehicles are subject to the car limit which sets the maximum base for depreciation.
The ATO occasionally adds a time-limited bonus like instant asset write-offs for those who are eligible.
In simple terms an asset (including a “capital” asset) is a resource owned or controlled by an entity that is expected to provide future economic benefits to the entity. Assets can be classified on the basis on whether they are physical aka “Tangible” or non-physical aka “Intangible” AASB138; and whether they are “current” or “non-current” AASB101.
Examples of Types of Assets
Current | Non-Current | |
Tangible |
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Intangible | NOTE: Intangible assets are usually Non-current by their nature. | Non-physical assets such as trademarks, patents, software, and goodwill. These can be significant for businesses, especially in tech and creative industries. (These assets are often subject to amortisation over their useful lives.) AASB138 |
What does it all mean – for my business?
Fixed assets and depreciation are crucial aspects of financial accounting in Australia. Depreciation plays a crucial role in capturing the economic reality of asset usage and managing financial resources effectively. Properly managing and reporting these elements helps businesses optimise their financial performance, adhere to tax regulations, and make informed investment decisions. Understanding the nuances of fixed assets, their significance, and the relevant tax implications is essential for financial health and strategic planning. Do it, make it fun and seek professional advice whenever you need to.
The end (nearly)
If reading this article has tickled your funny bone and you would like to know more, the ATO has a wealth of resources to choose from. MyCPE offers an excellent course “Assets and Depreciation – The Financial Impact!”.
On the topic of Assets and ‘preciation (both de- and ap-) your tax advisor should be your #1 go-to for professional advice.
If you would like to gain more control over implementing a process to manage the recording of information (including depreciation) about your businesses Fixed Assets, or just want a review to maximise the usefulness of your accounts Contact Us.