What is depreciation (and why does it matter)?

As an Australian business owner you’ll often buy assets (i.e. stuff) to help run your business. For example, a laptop, car, office furniture, and machinery. These things all cost significant sums of money. While they’re all vital for your business operations, their value isn’t static. Over time they wear out, become obsolete, lose their original worth or get replaced.​

This is where depreciation comes in.​

In simple terms, depreciation is an accounting method that allows businesses to spread the cost of an asset over a period of time (also known as ‘its effective life’).​

Instead of claiming the full cost of the asset as a deductible expense in the year it was purchased, you claim a portion of the cost each year based on its estimated lifespan.​

For example, if you bought a piece of machinery for $50,000 and it’s expected to last 10 years, you might claim $5,000 each year for 10 years, rather than claiming $50,000 in 1 year.​

Depreciation helps acknowledge that your assets contribute to your business’s income over its entire lifespan rather than only in the year it was purchased.​

Depreciation might feel like just another technical term, but it's very useful in the world of business.​

Reasons include: possible tax savings, knowing the real value of assets, better reporting, asset management and planning.​

This is often the most compelling reason for business owners to understand depreciation. In Australia, the cost of most depreciating assets is tax-deductible over their effective life. ​

Of course, a lower taxable income often translates to a lower tax bill, freeing up cash for other essential business activities. What business owner wouldn’t want that?​

Depreciation provides a more accurate picture of your business's profitability over time. By allocating the cost of an asset across a longer period of time, your financial statements will better reflect the true cost of running your business, rather than showing a massive expense hit in the year of purchase. This is crucial for internal decision-making, as well as for attracting investors or securing loans.​

A car bought for $30,000 isn’t worth $30,000 forever. Depreciation helps track how much its worth now, not just what you paid for it. ​

This is also known as its book value, which is the original cost of the asset minus any accumulated depreciation.​

Example: ​

Car was bought for $30,000​

Total accumulated depreciation (over the last few years): $20,000​

Current book value = $10,000​

Tracking depreciation can give you insights into the aging of assets. This can be extremely valuable for planning for replacements, upgrades or maintenance. It also helps ensure your operations remain efficient over time. Having an asset register that records this information is also useful for insurance purposes.​

Generally, you can depreciate assets that:​

Common depreciating assets include:​

You can’t depreciate things like stock, land, or everyday expenses like internet or electricity. (Land is generally not a depreciating asset as it typically doesn’t decline in value).​

There are a few different ways depreciation can be calculated, but you don’t need to do all the maths yourself. That’s what your accountant is for.​

Here are two common methods the ATO allows:​

You claim more in the earlier years, and less as the asset gets older. It’s like how a car loses most of its value in the first few years.​

You claim the same amount each year over the asset’s effective life. This is the simpler option for most people.​

The ATO provides guidelines on the ‘effective life’ of different assets.​

The rules around instant asset write-offs in Australia change fairly often. Sometimes, the government allows small businesses to claim the entire cost of an asset in the same year they buy it, rather than spreading it out.​

For example, if the threshold is $20,000 and you buy a $15,000 piece of equipment, you might be able to claim the full $15,000 that year. But if you buy something worth more than the threshold, it has to be allocated to a pool and depreciated at a set rate.​

These rules are often updated in the federal budget. In recent years, the instant asset write-off threshold has been set at $20,000, so many assets like phones and computers can be fully claimed in 1 financial year rather than over a longer period. Previously, the threshold was only $1,000, so most assets fell under depreciation rules.​

If you’re looking to buy a high-ticket asset, it pays to check with your accountant on the current rules so you’re aware of whether the item will fall under the instant asset write-off or standard depreciation.​

Depreciation is more than just an accounting term. It’s a valuable tool that can impact your business's profitability and tax position.​

Understanding how it works and why it’s important is useful for effectively managing your business assets, operational efficiency, and finances.​

For tailored assistance on how depreciation applies to your business assets and to ensure you’re maximising eligible deductions, its always recommended to consult your accountant.​

Beany are an online accounting firm in Australia that delivers big firm expertise without the big cost. We handle everything accounting-related (such as annual compliance, bookkeeping, financial insights and strategy), and help business owners make smarter decisions for their business and lifestyle through our responsive, friendly expertise.​