What is Depreciation and What’s it For?

What is Depreciation? As a non-accountant working in an accountancy firm, I thought it would be beneficial to at least get a slightly better understanding of what the accountants do so I dutifully signed up to an Introduction to Accounting course.

And it is way more interesting than I thought!

So that’s where this blog comes in; I’m currently learning about depreciation – a term that I have heard lots in the virtual corridors of Beany but have really paid very little attention to and when I suggested a blog on it, it was put forward that a non-accountant would be the best person to write it.

So, here it is (technical checking by Sue De Bievre, our CEO; just in case…..)

Depreciation is a useful beast.  Every company has assets i.e. stuff.  Some of it is ‘current’ which means it will be consumed within 12 months (think stationary, nails and screws; your consumables) and some of it is un-current i.e will have a longer shelf life (think vehicles, machinery, office chairs…).

Without going into too much detail, the un-current items get depreciated and there are 2 ways of doing it; one is over a pre-agreed shelf life of say 5 years for an item and the other way is by using the IRD depreciation percentage (I was very pleased when I realised I didn’t have to work that bad boy out!)  That’s where the clever accountants come in and work out which way is best for which asset.

Here’s an example to show you how this works:

Year 1
 – Buy a vehicle for $10,000.
 – You can claim depreciation of 30% in the first year.
 – This reduces your profit by $3,000 and you pay less tax of $840 (if profit left in the company)

Year 2
 – The vehicle is worth $7,000 now
 – You claim 30% x $7,000 = $2,100 and you pay less tax of $588.

Year 3
 – You sell the car for $6,000.
 – You can’t claim depreciation in the year of sale
 – But you can claim the loss – $7,000 less $6,000 = $1,000 loss and tax saved of $280.

Points to Note:

  • Depreciation is the ‘cost’ of the asset spread over several years (the estimated useful of the asset).
  • You can’t claim depreciation in the year of sale
  • If you sell at a loss, you can claim the loss. However, if you sell for a profit, you have to pay some tax back.  That is called depreciation recovered. In other words, the asset was effectively over depreciated and the IRD want to ‘recover’ that claimed depreciation.

Depreciation and the claims that are associated with assets can get a little complex which is why, typically, we sort it out at the year-end and make sure you’ve claimed everything that you can.

And what is the benefit of depreciation?  Long story short, it reduces the amount of tax you pay as the item sits on your profit and loss which reduces your income so you get taxed less.

If you are keen to know more, give the Beany support team a call on 0800 755 333

Written by our own Beth Aldridge, Ambassador of Happy.

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