Once you install asset management software and start keeping track of all your assets, you may feel your employees are doing a great job of learning the whole system. Still, there might be something you are not paying attention to that could lead to heavy losses later. Depreciation is directly tied to your assets, so you should never overlook it. A good grasp of fixed asset depreciation helps a business excel. Let’s start with what depreciation is.
Asset Depreciation: As an asset suffers regular wear and tear, its overall value falls. This loss of value is called asset depreciation. By the end of its useful life, the asset is worth only its scrap value.
Calculating asset depreciation matters if you want to save money, because depreciation on your assets can be claimed as a tax deduction. Most businesses that make smart financial decisions use this process.
Also Read: Accurate Asset Depreciation for Financial Reporting
The factors that are important when asset depreciation is calculated are:
- Useful Life: The period over which a company expects its asset to have value is its useful life. Depreciation is spread over this life.
- Value of Asset: Knowing the value of an asset tells you how much there is to depreciate. The scrap (salvage) value is usually subtracted from the cost of the asset to find the amount to depreciate.
- Method of depreciation calculation: Here is an example of how depreciation is calculated.
Let’s assume we have an asset that cost $50, with a useful life of 5 years and no scrap value. Using the straight-line method, we spread the total depreciation equally over each year, which comes to $10 a year, or 20% of the cost.
Other methods spread the same cost differently. A declining balance method charges more depreciation in the early years and less later on, which suits assets that lose most of their value soon after purchase, such as computers and vehicles. Whichever method you choose, the total depreciated over the asset’s life is the same.
What is Fixed Asset Depreciation?
Fixed asset depreciation is the depreciation calculated on any fixed asset your organization owns. It is an expense recognized gradually over the asset’s life cycle.
It reflects how an asset’s value is used up over time. Fixed assets, such as equipment and vehicles, are major expenses for any business. After a certain period, these assets become obsolete and need to be replaced. Assets are depreciated to recover their cost over their useful life.
What are the various benefits of depreciation?
- Helps in writing off asset value: To calculate depreciation, an organization first works out the depreciable value of the asset, which is usually its cost minus its salvage value. With this figure in hand, it is easy to write off the asset’s value and spread it across its useful life.
- Helps in tax reduction: Tax rules allow depreciation to be deducted. A depreciation expense lowers taxable income, which increases your tax savings. Because depreciation is deducted from revenue as an expense, it reduces the tax payable on the income your fixed assets help earn.
- Correct valuation of assets: Depreciation helps you find out what any asset is really worth. You work out its useful life, subtract the salvage value from its cost, and spread the result across the asset’s useful years.
- Recovering the cost of assets: Fixed asset depreciation shows the value remaining in each asset, so you can recover its true cost by making full use of it throughout its useful years.
Why is depreciation important?
Recovering the cost of an asset is a wise financial decision, because the cost can be spread across the asset’s useful years. When an organization knows how long its assets will last, it becomes much easier to decide how and when to buy new ones.
Calculating depreciation has a direct, positive effect on your business. Keeping track of depreciation on your assets may be difficult at first, but with fixed asset management software you can calculate depreciation easily. It lowers costs and adds to the value of your business, which is why it is worth a try.
To calculate depreciation properly, you need to know the actual cost of your asset, so always keep the purchase invoice from the day you buy it. You will also need that record to support your tax deductions. To make the most of your assets, record and value them accurately.
Depreciation is not calculated on every asset in the organization. Low-value items and items that last only a few months are usually expensed instead of depreciated.
Getting Depreciation Right for Your Business
Understanding depreciation helps you increase your potential savings, plan investments in assets, and set aside money to buy more. Fixed assets represent a large part of the value of a business, so it is very important to keep that information accurate. A business should always keep accurate asset records, because they show its financial position. Presenting true information builds goodwill and a positive attitude among customers toward your business.
Depreciation calculations can seem daunting to newcomers. If you are unsure which assets to depreciate, get in touch with Asset Infinity and we will help you get it right.