On this post we will talk about fixed asset depreciation and how it impacts your business. Conducting frequent fixed asset audits empowers your company to make important decisions based on the latest and most accurate data. An important reason for frequently auditing your fixed assets is to report precise gains and losses on your financial statements and especially when filling your taxes. Consequently, properly recording the depreciation of your fixed assets becomes extremely important when preparing balance sheets and tax reports.
We will cover what is depreciation of fixed assets, how to calculate the depreciation of your fixed assets, and how it impacts your business.
What is Depreciation?
Fixed asset depreciation calculation assumes that your fixed assets will be used for more than one accounting period. Therefore, depreciation is the methodical decrease in the documented cost of a fixed asset over its useful life. The reason for calculating the depreciation of fixed assets is to match a portion of its cost to the revenue that it generates. This is required under the matching principle; you record revenues along with their related expenses in the same reporting period. If you do not account for depreciation, the total cost of a fixed asset will be documented in the year of purchase. Resulting in a misleading report of the profitability of your business.
3 Factors to consider when calculating depreciation
- Useful life. It is the estimated lifecycle of a depreciable fixed asset, during which the company expects the asset will be productive. Depreciation is recognized over the useful life of an asset.
- Salvage value. It is the estimated resale value of an asset at the end of its useful life. Once a company disposes of an asset, depreciation is calculated based on the asset cost, less any estimated salvage value.
- Depreciation methods.
- Straight Line Depreciation: Same depreciation value is applied over the whole useful life of the asset.
- Reducing Balance Depreciation: Depreciation expenditure decreases at a constant rate throughout the useful life of an asset.
- Sum of the Year’ Digits Depreciation: Depreciation charge declines by a constant amount throughout the assets’ useful life.
- Units of Activity Depreciation: Depreciation charge varies with each period in proportion to the difference in the level of activity.
If, halfway through the useful life of an asset, its useful life or the salvage value change, you incorporate the adjustment into the depreciation calculation over the remaining life of the asset instead of retroactively changing any depreciation that has already been recorded.
Other Depreciation Considerations
- Depreciation is not related to the market value of a fixed asset. Market value may vary significantly from the net cost of the asset at any given time.
- Depreciation is an important concern in the calculation of a company’s cash flow. It is included in the calculation of net income, but does not involve any actual cash flow. Accordingly, a cash flow analysis asks for the incorporation of net income with a depreciation add-back for any depreciation recognized as an expense during that period.
Asset Panda Depreciation
Our system is an ecosystem, where you can track, manage, and support your fixed assets throughout their entire lifecycle. With Asset Panda every account is a premium account and therefore, every features comes standard. Wondering how to run a straight line fixed asset depreciation report on Asset Panda? Here’s a step-by-step guide.