Don’t have an appreciation for depreciation? You might be in trouble!
Alright, dad jokes aside, depreciation is an important part of your business finances. While it’s more of an issue for the accounting side than the bookkeeping side of things, it’s still something that all small business owners need to have a solid understanding of.
Any small business owner knows that their assets are important. Some assets such as inventory can be used to generate revenue, while others such as vehicles are essential in enabling your business functions.
And when it comes to assets however, many small business owners overlook depreciation.
Failing to properly understand and account for depreciation of your assets can be costly and can leave you with an inaccurate picture of your business’ assets.
But what exactly is depreciation? And why does it matter?
Buckle up, because our Melbourne bookkeepers are about to give you a quick crash course!
Our Melbourne bookkeepers defines depreciation
In short, depreciation is an accounting term that refers to when business assets lose their value over time – specifically, when fixed assets decrease in value.
According to international accounting standards, fixed assets are those that are:
- Retained for the long-term, and
- Are not intended for resale
And since these assets are held over the long-term, you’ll need to account for loss of value over that asset’s lifespan.
Examples of fixed assets include computers, vehicles, furniture, property and machinery, just to name a few. It even includes intangible (non-physical) assets such as intellectual property rights and patents.
A real-world example of depreciation
Say you run a hardware shop and you receive a shipment of hacksaw blades.
Since these blades are held with the express purpose of reselling them (hopefully within the next 12 months), they do not satisfy the criteria to qualify as fixed assets, and thus aren’t subject to depreciation.
But what if you purchase a truck to perform lumber deliveries to your customers’ homes?
This isn’t something you’re going to sell next week. And while you might sell it on later, that’s not the reason you bought it.
This is an example of a fixed asset.
What’s more, it’s also a great example of depreciation!
As we all know, vehicles immediately lose their value the moment you drive them off the dealer’s lot. And we haven’t even gotten started on general wear-and-tear either!
Over the years, the value of a vehicle decreases further, which is reflected in its lower resale price further down the line.
This drop needs to be accounted for when calculating the total value of your business’ assets. Hence, depreciation.
It’s important to note that not all fixed assets decrease in value. For example, land is a pretty major fixed asset that doesn’t usually depreciate.
Why is depreciation important?
Depreciation and business value
Your balance sheet is the most important financial report your business generates, telling you how much your business is worth.
One of its most important functions is tallying up and calculating the total value of everything your business owns asset-wise.
This can affect the valuation of your business if you’re planning on selling, and may even have an impact on your ability to secure a business loan.
As such an important report, it’s essential that all the information on it is as accurate as possible.
And calculating depreciation is an essential part of that!
Calculating depreciation helps you account for the way fixed assets decrease in value over time. Going back to the truck example, you don’t want to still be listing it at the purchase price, as this will result in an inaccurate picture of your assets.
Depreciation and expenses
Accounting for depreciation helps you reach a proper understanding of the costs of your business.
Specifically, depreciation is a non-cash expense. While it may not affect your bank balance, it still affects your expense reports.
Essentially, depreciation of assets represents wear-and-tear, turning it from a vague concept into an expense you can calculate by allowing you to put a definitive value on how much wear your business’ assets have undergone.
When combined with expenses tallied up by your Melbourne bookkeeper, your accountant is able to create a more accurate profit/loss statement for your business.
Depreciation and tax benefits
Did you know? Depreciation also has a role to play when it comes to how much tax your business pays!
That’s because depreciation on fixed assets affect how much capital gains tax (CGT) you’ll have to pay, which is the tax you pay on the resale of a fixed asset.
Since depreciation decreases the value of fixed assets, it impacts how much capital gain (profit) or capital loss (duh) you will receive on the sale, which in turn affects your CGT.
If a fixed asset is improperly valued without consideration for depreciation, you could end up paying the ATO more than you need to!
Unlike other capital assets (another word for fixed assets), there’s a special technique that’s used for calculating CGT on depreciating assets. Click here to learn more.
Call Maximum Business Solutions for better bookkeeping in Melbourne
Sure, depreciation may be more of an accountant’s job than a bookkeeper’s. However, that doesn’t mean we can’t help!
Our strength is our ability to create and implement custom cloud bookkeeping packages.
Conveniently enough, all three of the cloud platforms our Melbourne bookkeepers provide support for just so happen to include functions to automate depreciation calculation and management!
If need be, we can include these in your unique cloud bookkeeping solution, providing you and your accountant with all the information you need to make better decisions for your business.
Take our word for it: depreciation is not hard to work out… with the right help, of course!
Prefer a face-to-face meeting? We welcome guests at our bookkeeping office in Beaumaris!