Asset Depreciation

Note that earlier in this tutorial, we discussed the difference between Assets and Long-Term Assets. There, we stated the Assets are those used within 12 months, while Long-Term Assets are around for more than 12 months. However, most Long-Term Assets, except Land, will depreciate in value over time. This includes things such as equipment, furnishings, and vehicles—the fact is that these will need to be replaced over time.

Depreciation is useful because it balances out expenses vs. revenue on your balance sheets. For example, if you bought equipment for $50,000.00 that is meant to be used for at least 10 years, it does not make sense to expense the whole $50,000.00 amount in the first year. Instead, every year you should depcreciate the asset by $5,000.00 instead. This gives a more accurate description of the cost of the asset over a long period of time.

In accounting, the purpose of depcreciating an asset is to distribute the cost of the asset over a period of time, instead of all at once. Deprecriation expenses do not involve the exchange of cash, rather they exist for accounting purposes to redistribute the cost over a longer period of time. You can personally choose to depreciate an asset weekly, monthly, yearly, or some other fixed period of time. Typically most companies do this yearly, depending on how often your business makes financial statements.

Note that only assets that are around for over a year undergo depreciation. Supplies that are consumed within a year go directly under Expenses. Furthermore, assets that do not depreciate, such as land, do not fall under the category of depreciation.

As well, if you are leasing or renting a property, this would fall under an Expense as well. However, improvements made to the property, provided that they are there for over a year, undergo asset depreciation.

The Cost of an Asset

The total cost of an asset depends on a multiple number of factors:

• Cost of the Fixed Asset

  This represents the actual cost of the asset itself.

• Retail Sales Tax

  This represents the tax paid on the purchase of the fixed asset.

• Shipping and Delivery Costs

  This represents the cost it took to ship or delivery the asset to your place of business.

• Installation Charges

  This represents the cost it took to install the asset to your place of business.

• Other Costs

  This represents the other expenses required to make your asset usable in your place of business. For instance, if you bought computers for your business, and need additional hardware to make the network work, they would fall under Other Costs.

Calculating Asset Depreciation

Firstly, you must decide how long you plan on using your fixed asset for, to determine the asset depreciation amount per period.

Given all this information, you have multiple ways of calculating depreciation for a particular asset. First, you must consider the Residual Value of the asset. This represents the amount you believe you can sell the asset after a ceratin period of time. For example, if you bought a car for $30,000.00, and believe you can sell it for $5,000.00 in five years, then $5,000.00 wouldbe the residual value.

Method of Depreciation	Description
Straight Line	This method of depreciation assumes that your asset depreciates a consistent amount per period of time. In the case of the example above, the total depreciation amount is [Purchase Price − Residual Value] ÷ (total time between purchase and residual price). In the case above: [$30,000.00 − $5,000.00] ÷ (5 years) = [$25,000.00] ÷ 5 years = $5,000/year. Thus, the depreciation amount every year for the vehicle is $5,000.00. Of course, if you chose to depreciate the asset every month or week, you would adjust the time between purchase and residual price value (i.e. 5 years = 60 months &equals 260 weeks).
Double-Declining Balance	You want to use this method of depreciation when you believe that your asset is more useful at the beginning of purchase and becomes less useful as time progresses. In this model, the assetr depreciates more in the beginning, and less as time goes on. To find the percentage of depreciation, use the formula below: Percentage of Depreciation = 2 × (1 ÷ [Estimated useful life]) In the case of [Estimated useful life] = 5 years, 2 × (1 ÷ [5 years]) = 2 × 20%/year = 40%/year in depreciation. Calculating depreciation per year at 40% for the example above gives: End of Year 1: Note that the initial cost of the car is $30,000.00. 40% of $30,000.00 is $12,000.00. Thus, the depreciation expense for the year is $12,000.00, leaving the asset at a value of $18,000.00. End of Year 2: At the end of Year 1, the value of the car is now $18,000. 40% of $18,000 is $7,2000. Thus, the depreciation expense for the year is $7,200.00. This leaves the asset at a value of $10,800.00. End of Year 3: At the end of Year 2, the car has now depreciated to a value of $10,800.00. 40% of $10,800.00 is $4,320.00. The depreciation expense for this year is $4,320.00. This leaves the asset at a value of 6,480.00. End of Year 4: At the end of Year 3, the car has now depreciated to a value of $6,480.00. 40% of $6,480.00 is $2,592.00. However, if I were to apply the depreciation expense, it would bring the total asset value to a total of $3,888.00. However, this is lower than the determined residual value after 5 years. Thus, at this point, the deprecation value, to get to a total asset value of $5,000.00, would be $6,480.00 − $5,000.00, or $1,480.00. After this depreciation expense is applied, the asset will now have a value of $5,000.00. End of Year 5: Regardless of the value of the asset at the end of Year 4, we know that at the end of Year 5, the car asset will have a final residual value of $5,000.00. So regardless of what the value of the asset is at the end of Year 4, we need to apply a a deprecation amount so that the car asset will have a final value of $5,000.00. Extending on the example above, the car asset already has a value of $5,000.00 at the end of Year 4. Thus, the deprecation amount for the end of Year 5 is $0.00, and thus the final value of the asset will remain at $5,000.00.
Declining Balance	If you find that the percentage of depreciation from the Double-Declining Balance is too much, you can reduce the percentage. As a guide, it may be best to half the percentage determined from the Double-Declining Balance method. From the Double-Declining Balance method, we determined the percentage to be: = 2 × (1 ÷ (Estimated useful life)) Half of that would just be: = (1 ÷ (Estimated useful life)) For a duration of 5 years, this would end up being 20%/year, instead of the 40%/year calculated from the Double-Declining Balance method. Of course, if you please, you can choose any other percentage you would like (i.e. 15%, 35%, etc.).
Units of Production	This method is useful if you have a specific metric to determine the usefulness of an asset. For example, the mileage on a vehicle would be a great metric for Units of Production.. To determine asset depreciation per unit of production, use the formula: Depreciation per Unit = [(Total Cost of Asset) − (Residual Value)] ÷ (total estimated units) From the example above, if the total estimated milage is 100,000 miles, then by the formula, depreciation per mile is: Depreciation per Unit = [$30,000.00 − $5,000.00] ÷ (100,000 miles) = [$25,000.00] ÷ (100,000 miles) = $0.25/mile To determine the total depreciation after a year, determine the amount of units produced and multiply that by the rate calculated previously. In the case of above, if the vehicle waws driven 10,000 miles over the course of a year, then the depreciation amount is: = $0.25/mile × 10,000 miles = $2,500.00

Your choice of depreciation method may vary, and it may be best to ask your accountant for further advice.

Taxes and Depreciation

Unfortunately, the technique above cannot be used for determining depreciation calculations when it comes to paying taxes. In Canada, depreciation is not considered a deductible expense, and thus you must use the Capital Cost Allowance instead. This represents the amount you can deduct from your tax returns per year.

The Capital Cost Allowance is based off of the Declining Balance method; however, the Canada Revenue Agency has specifically chosen depreciation percentages depending on the class of item.

How long should I keep my asset?

It may be beneficial to ask outside opinion for how long an asset will last before needing replacing. Furthermore, it is worth thinking hard about how much you believe your asset's residual value will be at the end. Please be sure to consider maintenance of the asset, because otherwise your asset may not last as long as you intend it to.

Furthermore, it is best to keep a deprecation schedule for when you need to depreciate an asset. GridTracks provides an account description for all accounts, which is where you can add in the info per asset. Be sure to include all information required to calculate depreciation, such as original purchase date, original purchase price, residual value, useful life span, depreciation percentage or value for Unit of Production.

Impairment of Fixed Assets

There may be situations when your asset is damaged. For example, if your car is in a wreck, its value will decrease faster than the amount you have currently depreciated. It is best not to delay logging in this entry, as it is required to have a good grasp on the financials of your business.

You should be most worried of intangible assets like patents, as their value can change if the business goes in a different direction and thus it may be that the patent is no longer needed and thus no longer worth anything.

Logging in Asset Depreciation

When you do log in the depreciation, you will need the expense account Deprecation Expense, as well as the contrapositive asset account Accumulated Depreciation — Asset. Note that instead of decreasing the value of the asset directly, we use another asset account for accumulated depreciation. Note that while this is an asset account, it has a default credit (negative) balance, which is why it is called a contrapositive account.

Amortization

For copyrights and patents, they also undergo depreciation, as the government usually sets a limit to the exclusivity of these. However, because these things are not tangible assets, they fall under amortization rather than depreciation. You would use the same techniques above for determining amortization.

Next Steps

• Paying and Collecting Interest
• Finalizing Data
• Viewing Summary Data (Balance Sheet, Income Statement)
• End-of-Period Preparations

Credits

Please note that most of the information from this site is taken from the book "Bookkeeping for Canadians for dummies" by Lita Epstein and Cécile Laurin.

(Epstein, L., & Laurin, C. (2019). Bookkeeping For Canadians For Dummies. Hoboken, New Jersey: John Wiley & Sons, Inc.)