Depreciation and Fixed Assets

Depreciation
is a calculation to write off the value of a fixed asset over its useful
economic lifespan to the profit and loss account.

The
relevant sections of our Chart of Accounts are Expenses and Fixed Assets I’ve
copied these below

The
Depreciation can be calculated in a number of ways, but the entry should always
be debit to depreciation in Expenses on the Profit and Loss Account and credit
the Fixed Asset depreciation charge on the Balance Sheet.

The
effect of this will increase the expenses and lower the net profit and also
reducing the balance of the item in fixed assets on the balance sheet.

You
can either calculate depreciation using the straight-line method or the
Reducing balance method. One thing to remember is whichever method you use you
need to be consistent, you should not change the method of calculation of an
asset during its life span for instance if your depreciate a car at 25% on
reducing balance basis you should not change it in a later year to 25% straight
line basis, however if your client buys another car then you could change the
method of calculation for the new car.

Straight Line Method

This
is a fixed percentage taken from the original invoiced cost of the asset. For
example if the depreciation was 15% straight line and the asset cost £1000 then
you would deduct £150 from the value of the asset each year until the item was
written down to a nil value or disposed of.

You
will see in year 7 we have reduced the depreciation to £100 that’s because we
cannot depreciate the asset down to a negative value, for bookkeeping purposes
at the end of year 7 the asset has a ‘Nil Value’.


Reducing balance basis

This is calculated on a new value each year which is the previous year’s closing balance after depreciation was applied. Let’s assume the same asset as above which cost £1000 was depreciated by 15% reducing balance basis this would mean depreciation is calculated like this


 

 

Please
note that depreciation can be calculated monthly if your client wants monthly
management accounts from you but normally its calculated annually if you
calculate it monthly the annual equivalent is still 15%.

I
tend to find that the reducing balance method is good for motor vehicles as
they depreciate rapidly after purchase and the rate at which the depreciate
reduces as it gets older the reducing balance better reflects this process.
Also I find computer equipment and technology products other good examples for
the use of the reducing balance basis, one thing to bear in mind is that the
asset will not get to a nil value using this method.

The
Straight line method is good for depreciating the cost of a lease. If you pay
let’s say £10000 for a 10 year lease then during the 10 years it will reduce to
a nil value so depreciating the lease at 10% per year will write it off during
the 10 years.

The
following graph will show the difference in the two methods above at the rate
of depreciation on the assets as you can see using the straight line method the
asset is written off by year 7 whereas using the Reducing Balance Basis the
asset still has a value in year 7.

With the straight line method and as
you can see it is perfectly uniform rate of depreciation when we look at the reducing balance basis you can see the depreciation was
faster at first, then the amount of depreciation was slower towards the end of
the 7 years.

 

Fixed Asset Register

I
do find the use of a fixed asset register essential for my calculations of
depreciation but also there are time when a client will ask you what is a
particular asset on the books at, if you have more than one asset you will need
to work it out its much more professional to say to your client just a moment
and I’ll look at the fixed asset register for you. Its little things like this
that makes all the difference with clients.

Just
remember getting clients is expensive in advertising costs but also time (you
need to spend more time on a new job to get used to that clients business) the
best thing you can do is keep the clients happy so you keep them. That’s what
makes your business a success rather than you going round in circles.

I’m
trying during this course to not only help you to learn bookkeeping, but the
sensible tricks that will make all the difference to you. During the years, I
have had very good retention of clients and not always been particularly cheap
with fees, but clients have valued my service.


This
gives an example of two assets one bought in the year car AB12 ABC and one
brought forward from the previous year car ZX11 XYZ. Next year the cost B/F
would be £7500 for AB12 ABC and £4500 for ZX11 XYZ.

I
would personally prepare a fixed asset register for every separate class of
assets (i.e. Plant and Machinery, Fixtures and Fittings, Vehicles, Leasehold
Land and Property) there is not set rule for this I just simply find it more
helpful.


Purchase of Assets

When
your clients purchase assets and you enter them into your accounts you need to
be very clear with your bookkeeping entries as there can be a number of high-value transactions. Just a simple purchase of let’s say a motor vehicle from
the bank account for £10000 would be:

However
in many cases it’s not this easy your client may buy the same car for £10000
but pay £2000 from the bank account and get a £8000 loan for this the entries
would be:

With
purchases I always suggest that depreciation is pro rata for the period of
ownership therefore if I’m using 25% depreciation rate and my client bought an
asset (let’s assume it’s the car for £10000) 3 months before the end of the
year I would calculate my depreciation as follows:

£10000*25%=£2500
for the year and then apportion it for 3 months £2500/12*3=£625.

Sales of fixed assets

When
selling assets we need to account for any differences for the difference in value
obtained for the asset compared to the amount we have it valued for in our
bookkeeping. This is where your fixed asset register will make your life so
easy (and the less professional bookkeepers who don’t bother with fixed asset
registers) will have to start working the net book value out.

So
let’s assume our client sells a car that cost £10000 and has been depreciated
by £5781.25 over 3 years and therefore has a net book value of £4218.75 and
that when he sold it he got £5000 for the car. He actually got £781.25 more
than we have it on our books for. This means our depreciation is too high and
consequently we have reduced his profits too much over the cars lifetime. We
need to adjust this now to correct the imbalance.

I’m
assuming he got the money paid into his bank account for the car.

So
what are the transactions?

We
need to remove the asset from our accounts so if we think back our purchase
entry would have added £10000 to the fixed assets subsequently we would have
charged £5781.25 to the fixed asset depreciation. Our fixed asset would look
like this:

We
need to therefore post a credit for £10000 as that’s the full value added to
our assets and Debit £5781.25 to the depreciation element this is because we
need to remove both from the balance sheet and entering and equal and opposite
entry will do this for us we also need to account for the money going into the
bank account and the profit on the sale of the asset.

Our
transactions we need in full (assuming we sold the vehicle of 31st March)
are:

In
this example the credit to
Expenses/Profit or loss on sale of fixed asset is showing a profit on
the sale of the asset because it cost £10000 had been depreciated by £4781.25
so had a value on the business books of £4218.75.  As the car was sold for £5000 this leaves us
with £781.25 surplus that needs to be added to the profit and loss account as an
income (hence its shown as a credit) the surplus is due to the car being
depreciated at a rate faster than it lost value and the depreciation in
previous years was overstated as a result.

The adjustment by putting this difference back as a credit has balanced
that up for us.

Disposals at Nil Value

Also
consider any assets your business has that have been scrapped at nil value during
the year, it’s not always practical to do but it would be a good idea
(especially if you have some high value assets) for you to review the assets listed on your asset register at least once a year. Any items scrapped would effectively be treated as though they
had been sold but with nil proceeds

So
let’s assume you had a burglar alarm and it cost £6000 had been
depreciated by £4675 but during this accounting period had broken and been
thrown away our entries would be:


In
this example the debit to
Expenses/Profit or loss on sale of fixed asset is showing a loss on the
sale of the asset because it cost £6000 had been depreciated by £4675 so had a
value on the business books of £1325.  As
the item was thrown away because it was broken the business got no money for
the asset so the £1325 needs to be written off the profit and loss account as
an expense (hence it’s shown as a debit) the shortfall is due to the burglar
alarm being depreciated at a rate slower rate than it lost value and the
depreciation in previous years was understated as a result.

The adjustment by putting this difference back as a debit has balanced
that up for us.

What if there’s a part
exchange?

So
let’s assume a car was bought for £15000 on 31st March, sold a car
that cost £10000 and has been depreciated by £5781.25 over 3 years and
therefore has a net book value of £4218.75 and that when he sold it he got
£5000 for the car. We also assume the balance for the vehicle was paid for from
the bank account £10000.


Now
let’s assume a car was bought for £15000 on 31st March, sold a car
that cost £10000 and has been depreciated by £5781.25 over 3 years and
therefore has a net book value of £4218.75 and that when he sold it he got
£4000 for the car. We also assume the balance for the vehicle was paid for from
the bank account £11000.

Freehold Land and
Property

We
would not normally depreciate Freehold Land and Property unless it was
something of a naturally reducing value for instance a mine or quarry where the
value would decrease as the raw material was extracted from it.

You
may find some ‘portable buildings’ such as farm buildings or storage that is
not of regular construction (prefabricated buildings) that have a limited
lifespan listed under Freehold Land and Property from a previous bookkeeper or
accountant and these would need to be depreciated.

I
would normally class such items as Plant and Machinery, it’s one of the
unfortunate areas of our profession that things could quite legitimately be
classified differently by different people.

 

Amortisation

Is
effectively a form of depreciation it’s used when someone buys goodwill when
they purchase a business. The general rule is it should be amortised over its
useful economic life. Unlessyou know of another reason (such as
industry standard) I tend to find writing it off over ten years (10% straight
line basis) a good compromise of timely reduction without unduly lowering the
profit of the business.

The
transactions are

Debit
Expenses/Amortisation in the Profit and Loss account

Credit
Goodwill in the balance sheet.

The
chart below will demonstrate the writing off of goodwill on a 10 year straight
line basis with a starting value of £20,000

As
you can see by the blue line I’ve drawn in the graph, the amortisation was the
same amount year on year.

Please
Note that if the proposed life of the purchased goodwill is 20 years or more,
then the normal action would not be to amortise the goodwill within the
accounts.

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