Tag Archives: depreciation

Fixed Assets and Depreciation

Both accountants and business people are grappling with the controversial accounting term known as depreciation. When financial statements are prepared the depreciation figure can be confusing. It can be too high at times, or too low, or just not properly done at times.

What is depreciation?

It is the accounting term used to describe the wear and tear of assets over a certain period of time. Depreciation is written-off against the income statement, based on a certain rate, and reduces assets on the balance sheet. Since it affects the bottom line, profits, it should be reasonable and fair. When profits on the disposal of assets are measured, the depreciation rate can affect that profit as well.

To derive maximum benefit from the business assets, the services of experts have to be considered. Depreciation percentages are easy to grasp, but it is with the implementation where businesses can encounter many problems.

Be selective with the accountant that will deal with your assets and taxes.

The accountant or tax consultant, should not only be conversant with the basic bookkeeping entries, but also with the fixed assets register, as well as complex developments in International Financial reporting Standards and changes in tax laws.

Mistakes and neglect with the fixed assets of a business’s, can result in losses running into thousands.

In as much as the services of outsiders are encouraged, there is just no getting away from the fact, that the business owner should become more hands on in the management of the businesses assets.

An expert can help, but he/she is not on your premises on a daily basis.

Since fixed assets, create economic benefits, the management and utilization of your assets to derive further economic benefits, in these precarious economic times, cannot be overlooked. Also take note of the provisions that propose depreciation on buildings. Land however appreciates, and rarely depreciates.

With the changes in International Financial Reporting Standards, radical changes from these bodies have been proposed. Useful life and economic life, in depreciation, is not necessarily the same thing. We furthermore have to look at prescribed statutory tax rates, which differ vastly from normal depreciation rate, and how that would affect the bottom line in a business.

No transaction for depreciation will pass through your physical books. The depreciation amount will be based on prescribed guidelines to determine the amount. The entry is based on no source document, and is known as a “book entry. What makes depreciation more contentious is the fact that it is a book entry. So even if the books are neatly prepared and balanced, the “depreciation factor”, leaves room for manipulation. Tampering with the depreciation rate/amount can result in either a loss or profit depending on the circumstances.

Even if strict International Financial Reporting Standards (IFRS) guidelines are followed, the carrying values and residual values can be tampered with.

A reasonable estimate could be 25% on machinery, but what if the machine is used for more than four years? Or alternatively, a computer can be used for 1 year whilst a depreciation rate of three years was provided for.

The following points are crucial for depreciation;

· Depreciate on a systematic basis
· Review depreciation methods annually
· Review residual values and useful lives annually.

Apart from IFRS, guidelines, the business should have clarity of the exact amount of years the asset will be used for.

Before calculating depreciation figures, thorough research should be performed on the fixed assets, its true values, residual values, useful life and economic life. Since these concepts are vital when final calculations are performed.

Depreciation-Useful Life, or Economic Life

 

Depreciation is the definition in accounting for a reasonable estimate, in monetary terms for the loss of value of an asset over a period in time. Since most assets are capitalized on the balance sheet, in financial statements, the “cost of depreciation”, is provided as an expense on the income statement.

 

Many debates on depreciation are continuing in accounting circles, since it is difficult to establish what would constitute a “reasonable estimate”. It was furthermore accepted, until recently, that land and buildings cannot depreciate, but appreciates. Recent developments, however, have now implemented depreciation on buildings.

 

Tax “write-offs”, on assets complicates matters further, since prescribed statutory rates for tax reductions are higher than depreciation rates, thus creating variances between tax values and book values of assets.

 

It is my contention that asset accounting can only be performed thoroughly, with the assistance of an astute accountant. The accountants know how on fixed asset registers, accounting standards and firm grasp of tax legislation is vital.

 

Whereas tax writes offs on assets are higher, the trend in accounting is to depreciate assets in terms of its useful life, and not its economic life. The prescribed rate for a computer in tax would be three years or 33, 3%. But a business could only use it for 6months and sell it as a scrap. This 100% provision for depreciation, as useful life, should be factored in. Office furniture could be utilized for 5 years, and then scrapped, but tax rates could prescribe four years, for a tax write off!

 

The rate that businesses would depreciate their assets at coincides with the economic life of an asset. So accepted economic life is useful life for business assets.

In non-governmental organizations and non profits (churches etc) the picture becomes very confusing. Churches will retain assets such as furniture for up to 40 years. Even computers that businesses normally upgrade from 6 to 12 months are used for 3 to 4 years!

 

So if the useful life method is applied, in non-profits ,assets could have a depreciation rate as low as 2%. Accounting standards expect fair presentation. Depreciation rates, for NGO’s and non-profits should be carefully applied.

 

No one expects a business owner or director, of a Non Profit Organization to understand these concepts, just to ensure that at the very least, a proper asset accounting system is in place.