11 January

Book Depreciation vs Tax Depreciation - An Overview

What is depreciation?

Depreciation occurs when a business asset decreases in value over a period a time due to the ageing and wearing out of the asset. Each individual asset (often know as a plant item) has an effective life. And it is important to note that these effective lives can be different from one industry to the next.

For example, the value of a chair in a dining area of a pub will gradually depreciate down to $0, over an 8-year effective life. If that chair is in the drinking area of a pub, the depreciation (or decline in value) is expected to occur faster, and it can lose its entire value over an effective life of just 5 years.

What are the different depreciation methods?

Just as there are differences in the effective lives, there are a number of ways in which to account for depreciation and the most commonly seen are the Prime Cost method and the Diminishing Value method.

Prime Cost also known as straight line depreciation, depreciates your asset the same amount every year until the value is $0. For example, an $8,000 carpet asset with an effective life of 8 years will depreciate $1,000 each year.

Diminishing Value depreciates an asset by a higher percentage of the value in the first few years of its effective life. Using the example from above, that same $8,000 carpet asset with an effective life of 8 years could depreciate $1,995 in year 1, then $1,501 in year 2, then $1,126 in year 3, $845 in year 4 etc.

Why is depreciation so important?

There two key reasons for you to understand depreciation and two areas that you will apply the decline in value, they are your business book depreciation and tax depreciation.

What is book depreciation?

Book depreciation is accounting for the decline in asset values within your business’s financial records.

The depreciation of these assets is effectively an “expense” to any business. It will attribute to the cost of doing business as eventually the items will wear out and need to be replaced. It should be included as an expense when calculating profit as failure to do so will mean you think your business is making more profit than you really are.

Likewise, the decline in the value of your assets will affect the overall true and perceived value of your business and your books (or accounts) need to reflect this. By accounting for the decline in your assets, you will have a true indication of your business’s financial position – particularly important if looking to branch out, invest, loan against or even sell your business for a fair price.

What is tax depreciation?

Tax depreciation is the process of applying the decline in asset values to your tax return in the form of a tax deduction. Just as other expenses can be deducted, so too can the ageing and wearing out of an asset over time.

The Australia Tax Office Tax Rulings provide standardised effective lives across all qualifying assets and industries as a guideline, however, there are also a number of schemes such as accelerated depreciation, low-value and low-cost pooling and immediate write off that can help to aggressively write off these values for taxation. For this reason, the most effective way to capture your maximum tax depreciation deduction is to order a tax depreciation schedule prepared by a qualified quantity surveyor.

What depreciation should I use?

Although it can appear difficult and complicated, your accountant and their tax depreciation specialist can help to set up your registers and books as well as arrange your tax depreciation schedule ensuring that business books as well as your tax affairs are in hand.  

To know more about obtaining a tax depreciation schedule for your business and/or assets or those of your client’s, contact our Capital Claims Tax Depreciation Specialist, Alex Konjarski on 1300 922 220 or alexk@capitalclaims.com.au.

 

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About Mark Wilkins

Mark is an expert quantity surveyor, business owner, public speaker and property developer. With 20+ years experience in the construction and quantity surveying industry Mark’s specialist expertise have been sought in consultant capacity by professional bodies such as the National Institute of Accountants and the National Tax and Accountants Association, and he has presented at various property and tax seminars and expos nationwide. Mark holds a Bachelor of Construction Management from the University of Newcastle, is an affiliate member of the Australian Institute of Quantity Surveyors and a Registered Tax Agent.

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