Whether you’re a small, medium or large business, purchasing AV or IT equipment can be a big investment. To make most of your investment, your equipment needs to be actively accounted for and managed. And that’s where depreciation comes in.
So let’s grab a coffee and go over the basics together!
Depreciation is a key component in understanding your business’ profitability and is recorded on the income and balance statements.
As a business, you can depreciate long-term assets for both tax and accounting purposes. The rules of calculating depreciation might slightly vary, however, based on the location your company is registered at, and the company’s geographical expansion.
So before we get to the calculation part, it’s good to know that:
“In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in a systematic manner until the value of the asset becomes zero or negligible.”
In other words, after having purchased your AV and/or IT equipment, you’ll probably start using them on a daily basis. This means they tend to wear down over time and thus, become less valuable. The declined value (of the fixed asset) is called “depreciation”.
Examples of fixed assets are buildings, office furniture, AV and IT equipment, machinery, etc. They are a critical component for evaluating your business valuation and understanding your business’ profitability.
You can calculate the depreciation of your assets in a few ways, but depreciation rates are generally calculated under the straight-line method, according to the minimum and maximum period of useful life of the assets.
You basically expense the asset in a straight-line and it involves simple allocation of an even rate of depreciation every year over the useful life of the asset. This method is calculated by subtracting an asset’s expected residual or salvage value from its capitalized cost and then dividing this amount by the estimated useful life of the asset. Or:
In order to calculate depreciation using this method, you’ll need the following three inputs:
The useful life is the time period over which the organization or company considers the fixed asset to be productive. Beyond its useful life, the fixed asset is no longer cost-effective to contribute to company operations. The useful life is measured in years.
The asset cost is the total price of the asset (this may or may not include taxes, shipping, delivery, fees, and preparation/setup expenses).
When a fixed asset comes to the end of its useful life and is fully depreciated, the business no longer has to report the fixed asset as an expense. The company may continue to use it or consider selling it at a reduced amount. This is known as the salvage value of the asset.
As you should do it on the useful life of an asset, the salvage value should be reviewed at least once at each financial year-end. And if expectations would differ from previous estimates, the change should be accounted for as a change in an accounting estimate.
Let’s say you purchase a brand new camera. The asset cost is $6,000 and it has an expected residual or salvage value of $2,000. Plus, it is expected to be in service for eight years. Given these assumptions, its annual depreciation expense is:
= (Cost – residual value) / number of years in service
= ($6,000 – $2,000) / 7 years
= $4,000 / 8 years
= $500 depreciation per year
The straight-line depreciation method allows you to use your AV or IT equipment and spread the cost across the time you decide to use it. Instead of one, potentially large expense in one single accounting period, the impact on your company’s net income for each period will be smaller.
Once you have calculated the depreciation expense of your assets, you’ll know how much of the asset’s total cost should be expensed each financial period.