Depreciation expenses are the expenses charged to fixed assets based on the portion of assets consumed during the accounting period based on the company’s fixed asset policy.
The expenses that charge during the period (monthly or yearly) are recorded in the company’s income statement.
The accumulation of it is recorded in the accumulated depreciation, the contra account to the fixed assets, in the balance sheet.
The same types of fixed assets of different entities might be charged the expenses differently. Those entities might have different accounting policies, depreciation rates, useful life, and methods.
The recognition of depreciation expenses comes from the accrual basis, which means the company’s money spent to purchase the assets should not be considered as expenses immediately in that period of purchasing.
They should be charged as expenses in the period they are used and based on how they are used.
Those assets should be considered expenses in the income statement based on the systematic way or proportion they are used as we contribute to generating income or running operations.
For example, based on the number of hours they are using and their contribution to earning.
The process of allocating the expenses of purchasing fixed assets for the period of time is call depreciation.
Depreciation from IFRS Perspective:
If your financial statements are prepared based on IFRS, IAS 16 Property, Plant, and Equipment are the standard for dealing with depreciation.
Two accounts need to record depreciation expenses: depreciation expense, recorded in the profit and loss statement for the period incurred based on the entity-specific accounting policy.
And other is the accumulated depreciation expenses. It is the accumulation of the depreciation expense charged to the property, plant, and equipment since the beginning.
This accumulation expense reduces the book value of property, plant, and equipment at the end of the charging period.
Many methods allow being used for depreciation. Also, explain the detail in this article or change them. Click here for a detailed step-by-step guideline: Five Depreciation methods allowed by IFRS.
Example and How to Records Depreciation Expenses:
For example, if the depreciation charged during the period amount to USD1,000, then it will record as the following:
- Depreciation Expenses: USD1,000 (Dr) in Income Statement
- Accumulated Depreciation Expenses: USD1,000 (Cr) in Statement of Financial Position
The expenses charged during the period are based on the entity’s rate to the specific fixed assets. It is normally different from one entity to another.
- The debit amount of USD1,000 to the income statement will increase the expenses line of the income statement and subsequently reduce the net income.
- The credit amount of USD1,000 on the balance sheet will increase the accumulation expenses and reduce the net book value of fixed assets at the end of the period.
So, when you recognize depreciation expenses in the financial statements, the expenses in the income statement will increase, and assets in the balance sheet will decrease.
Noted: Fixed assets are the assets that the normal use for more than 12 months with the entity setting specific amounts. If its value reaches the set amount, those assets are treated as Fixed Assets.
The assets normally treated as Fixed Assets are an office building or building belonging to the entity, land belonging to the entity, computer equipment, entity care, and others.
Fixed Assets are treated as long-term assets and reported under the assets in the Statement of Financial Position.
Here are the items of Fixed Assets that need to be depreciated:
- Property Plant and Equipment.
- Building: Officer building owned by the company or under the finance lease.
- Computers: The computer owned by the company.
- Printers: a printer that the company purchases or owns.
- Machinery: machinery owned by the company or under the finance lease.
Many depreciation methods allow by IFRS, but IFRS recommends the three methods mentioned in IAS 16.
The double-declining balance technique believes that the assets are more productive in the first year and less productive in the subsequent years.
That is the reason double-declining balance charges a large amount at the beginning and then subsequently reduced.
Straight Line Basis:
The straight-line method is charged the depreciation expenses equally throughout the life of assets. This kind of method is popular as it is straightforward to calculate.
Production or Activity Depreciation Method:
Production or activity depreciation method. This method charges based on the production or activities proportion to the total volume that the assets are expected to produce.
Accounting Depreciation VS Tax Depreciation:
Before going into the difference between Accounting Depreciation and Tax Depreciation, we would like to explain Accounting Depreciation and Tax Depreciation.
- Accounting Depreciation is the Depreciation Expense charged to the Fixed Assets according to the Accounting Policies of those entities. For example, the entity purchases care for office staff use, and the value of the care is USD40,000. The accounting policies for this kind of assets would be over four years or 25%. In this case, the Accounting Depreciation would be USD10,000 per year.
- Tax Depreciation is the depreciation expense charged to the fixed assets according to the tax allowance that the entity is operating in. The allowed rate of depreciating the tax as purchased above is only two years or 50%. In this case the, tax depreciation for the case is USD20,000.
Therefore, the main difference between accounting deprecation and tax depreciation is the rate that applies to the specific assets.
In this case, mainly to avoid the difference, the company usually adopts an accounting policy consistent with tax allowance.
In a typical case, when there is a difference between accounting and tax depreciation, this would differ from the net book value of fixed assets per accounting and tax. This difference creates a deferred tax.
The difference is over or Under and Results in Deferred Tax Assets or Deferred Tax Liabilities. The Deferred Tax Assets or Liabilities are calculated by multiplying the net book value @ tax rate.