Depreciation expenses are the expenses that charged to fixed assets based on the portion that assets consumed during the accounting period according to the entity’s accounting policy.
The same types of fixed assets of different entities might be charged the expenses differently. This is because those entities might have different accounting policies specifically different depreciation rates, useful life, and methods.
The recognition of depreciation expenses come from the accrual basis which means the money that the company spent to purchase the assets should not consider as expenses immediately in that period of purchasing.
They should be charged as expenses in the period that they are used and basing on how they are used.
Those assets should be considered as expenses in the income statement based on the systematic way during the period or proportion that they are using as we as a contribution in generating income or running operation.
For example, based on the number of hours they are using, and the amount that they are contributed to earning.
The process of allocating the expenses of purchasing fixed assets for the period of time is call depreciation.
IFRS to deal with Depreciation:
If your Financial Statements are prepared based on IFRS, the standard that deals with depreciation are IAS 16 Property, Plant and Equipment.
There are two accounts that need to records depreciation expenses: one is depreciation expense which is recorded in the statement of profit and loss for the period it is incurred based on the entity-specific accounting policy.
And other is the accumulated depreciation expenses. It is the accumulation of the depreciation expense that charged to the property, plant, and equipment since the beginning.
This type of accumulation expenses reduces the book value of property, plant, and equipment at the end of the charging period.
There are many methods that allow being used for depreciation. Also explain detail in this article or you change click here for detail step by step guideline: Five Depreciation methods that allow by IFRS.
Example and How to Records Depreciation Expenses:
For example, if the depreciation charged during the period amount of $1,000, then it will record as the following:
- Depreciation Expenses :$1,000 (Dr) in Income Statement
- Accumulated Depreciation Expenses :$1,000 (Cr) in Statement of Financial Position
The expenses that charged during the period is based on the rate that the entity provides to the specific fixed assets, and it is normally different from one entity to another.
- The debit amount 1,000 USD to income statement will increase the expenses line of the income statement and subsequently reduce the net income.
- The credit amount 1,000 USD in the balance sheet will increase the accumulation expenses and subsequently reduce the net book value of fixed assets at the end of period charging.
Noted: Fixed assets are the assets that the normal use for more than 12 months periods with the specific amounts that the entity set if its value reaches the set amount, then those assets are treated as Fixed Assets.
The assets that normally treat as Fixed Assets are an office building or building that belong to the entity, land that its belonging to the entity, computer equipment, entity cares, and others.
Fixed Assets are treated as long-term assets and reports under the assets in Statement of Financial Position.
Here are the items of Fixed Assets that need to be depreciated:
- Property Plant and Equipment.
- Building: Officer building own by the company or under the finance lease.
- Computers: The computer own by the company.
- Printers: a printer that the company purchases or own.
- Machinery: machinery owned by the company or under the finance lease.
There are many depreciation methods that allow by IFRS but here are the three methods that mention in IAS 16 which recommended by IFRS.
Double-declining balance technique believes that the assets are more productive at the beginning of the first year and less productive in the subsequent years.
That is the reason Double-declining balance charge the large amount at the beginning and then subsequently reduce.
Straight Line Basis:
The straight-line method is charged the depreciation expenses equally over the period of life of assets. This kind of method is popular as it is very easy to calculate.
Production or Activity Depreciation Method:
Production or activity depreciation method. This method charge based on the production or activities in proportion to the total volume that the assets are expected to produce.
Accounting Depreciation VS Tax Depreciation:
Before going to the different between Accounting Depreciation and Tax Depreciation, we would like to explain what is the Accounting Depreciation and What is the Tax Depreciation.
- Accounting Depreciation is the Depreciation Expense that charged to the Fixed Assets according to the Accounting Policies of those entities. For example, the entity purchase care for office staff use and the value of the care is $40,000. The accounting policies for this kind of assets would be over four years or 25%. In this case, the Accounting Depreciation would be $10,000 per year.
- Tax Depreciation is the Depreciation Expense that charged to the fixed assets according to the tax allowance that the entity operating in. Let say, the allowed rate of depreciating the tax as purchase above is only two years or 50%. In this case the, tax depreciation for the case is $20,000.
Therefore, the main difference between accounting deprecation and tax depreciation is the difference in the rate that applies the specific assets.
In this case, mostly, to avoid the different the company usually adopt the accounting policy consistent with tax allowance.
In normal case, when there is the difference between accounting and tax depreciation, the subsequent of this would differ from the net book value of fixed assets per accounting and per tax. This difference creates a deferred tax.
The difference is over or Under and Result Deferred Tax Assets or Deferred Tax Liabilities. The Deferred Tax Assets or Liabilities is calculated by multiply the difference of net book value @ tax rate.