You may have heard your accountant, or simply another business owner, mention deprecation. It’s a term that is thrown around a fair amount in the accountancy world, but do you fully understand what deprecation is?
In simple terms, depreciation is a method of splitting the cost of an asset covering the length of its useful life. An asset can be anything from a building, to machinery, vehicles or computer equipment. For example, if you purchased a computer for £600 that is expected to be useful for the next three years then you would show a cost of £200 a year in the company accounts.
However, the most important question you will most likely be thinking is how does this affect your business? We’ve summarised the most important impacts to your business below.
- Business income – depreciation doesn’t directly affect your business tax, instead there is a system in place called capital allowances. This covers all tax deductions relating to assets on the tax return directly, this is slightly more complicated, and we will be looking to go further into it in a future post.
- Cashflow – deprecation doesn’t directly affect your cashflow either, it is an expense but as it doesn’t involve the movement of cash it is removed when completing your cashflow. Instead, the cash movement is recorded on the date of purchase, as this is when the cash is actually spent.
- Planning replacement of assets – depreciation can help you understand how long an asset would be useful, and when it may need replacing, giving you time to put funds aside and plan for the expense.
- Better financial reporting – depreciation affects your balance sheet by reducing the value of assets over time, and your P&L statement by smoothing out the cost of fixed assets over time.
If you’d like more information on depreciation, or anything else, please get in touch with us.
