Asset depreciation in Tax.

[redarrow]

Hey,

So I'm hoping some tax fundi can explain this.

How exactly does depreciation work? Is it merely another way of claiming the cost of an item or something else?

I.e., Business buys an office PC for say R6k. This gets claimed as a business expense. Where does depreciation fit in?
Is it above this or is it another means to the same end as in claiming the R6k over x number of years instead of outright?

Thanks.

 

[wentworth65]

PCs are normally written off over three years. Straight line method is used .

 

[redarrow]

PCs are normally written off over three years. Straight line method is used .

Thanks, but that doesn't really answer my question.. :erm:

 

[saturnz]

The tax authorities will have their own rules for depreciation, for example in the mining sector capital equipment for tax purposes are written down pretty quickly but in economic and accounting terms they may written down at a much slower rate. So from a tax perspective it is to incentive capital investment where required.

Where there is abuse of rules then the tax authorities may then prolong depreciation deductions.

 

[agentrfr]

Depreciation tax is a method by which you allow for the depreciation of an asset to occur at a sensible rate, since your asset value in the books does not retain its worth. This way you are allowed to count the depreciation as an expense to balance the ledger. This practise avoids over-inflating your company's asset value.

Various methods are used, but it really depends on the item in question and the industry the business is in. Computers, as stated above are normally taken down to zero value after three years using the straight line method. Other methods include the Declining Balance Method, Double Declining Method and the Modified Accelerated Cost Recovery System. MACRS is most often used in Engineering applications. Straight line method is usually used for much smaller assets. The complexity of the depreciation method is usually linked to the original asset price of the item when it was bought, hence small things use a simple linear method, things like cars and property usually use a declining method, and massive things like a Chemical Processing Plant use MARCS.

The entire point of this is so that you can call it an expense and not have to pay the implied tax on it if it was not an expense (in that case you would have to buy a new one using last month's money from gross profit that has already been taxed). You get more bang for your buck this way.

 

[redarrow]

The entire point of this is so that you can call it an expense and not have to pay the implied tax on it if it was not an expense (in that case you would have to buy a new one using last month's money from gross profit that has already been taxed). You get more bang for your buck this way.

Thanks.. I'm still not sure I'm getting it.

Here's how it was explained to me by er, someone.. or perhaps this how I (mis)understood it, the part that's confusing me is that it sounds like you can claim twice on something:

Ok, random numbers incoming..

Bob makes 100k net, the only cost he incurred was buying his office PC which cost R10k.
So he made profit of R90k considering that the R10k PC was a business expense. Can he now somehow magically claim a depreciation on that PC further reducing his profit margin? I.e., depreciating it at 33% per year would mean a further R3300.00.

So profit is now: R 86 700.00 (for this year).

Is this right? Because it sure as hell doesn't look right to me and yet this is how it was previously explained to me, and seriously I've googled it to death and cannot find a definitive answer on this.

 

[donaldza]

Thanks.. I'm still not sure I'm getting it.

Here's how it was explained to me by er, someone.. or perhaps this how I (mis)understood it, the part that's confusing me is that it sounds like you can claim twice on something:

Ok, random numbers incoming..

Bob makes 100k net, the only cost he incurred was buying his office PC which cost R10k.
So he made profit of R90k considering that the R10k PC was a business expense. Can he now somehow magically claim a depreciation on that PC further reducing his profit margin? I.e., depreciating it at 33% per year would mean a further R3300.00.

So profit is now: R 86 700.00 (for this year).

Is this right? Because it sure as hell doesn't look right to me and yet this is how it was previously explained to me, and seriously I've googled it to death and cannot find a definitive answer on this.

No that's not right. You can't claim the PC as an expense as it is classified as an asset.

Your R100k profit will stand, we will then be able to write off the R10,000 PC expense over 3 years (eg R3333 per year, straight line method).

Therefore in your first year your taxable income will be R96,667.

 

[redarrow]

No that's not right. You can't claim the PC as an expense as it is classified as an asset.

Your R100k profit will stand, we will then be able to write off the R10,000 PC expense over 3 years (eg R3333 per year, straight line method).

Therefore in your first year your taxable income will be R96,667.

Thanks for the clarification, this is what I really wanted to know.

 

[Paul Hjul]

I am not a tax or accounting fundi at all - my copy of Gripping GAAP (a couple of editions back) is sitting with my brother and the last time I did any accounting was in High School - but I think you are making the mistake of thinking of depreciation as a "tax thing". It isn't a tax thing although it has obvious implications for tax. Even an enterprise that does not pay tax has depreciation.

When your business buys equipment it is converting one asset (money) into another (equipment) or it is assuming a liability (purchase on credit) and acquiring an asset. Everything is recorded and you have the double entry principle. The assumption is that something doesn't become worthless at some magical point but rather that it depreciates over time so this fiction is dealt with using a concept of depreciation. There are different ways in which depreciation can be calculated and different things depreciate differently. Using buying computers as an example: You buy 15k worth of computers as a business today and there will be linear depreciation on the computers over 5 years, at the end of the year the computers have depreciated by 3k. The purchase of the computers was NOT an expense it was recorded as an acquisition of capital; for the end of year financials the asset value of the computers must be 12k. Your business takes some of its profit and buys additional computers for 15k which also depreciate linearly over 5 years; so end of Y2 you have 6k depreciation and 24k worth of computers. In Y3 you don't buy any computers, you dispose of some of a keyboard for Y1s buy and have to record that in your inventories; at the end of Y3 you have 6k depreciation for the year of 18k worth of computers. Y4 has you buying another 20k worth of computers and at the end of the year you experience 10k depreciation (3k of Y1 buy, 3k Y2 buy and 4k off Y4) and 38k worth of computers. Y5 doesn't have any purchases so its 10k depreciation and 28k worth of computers - now the assumption is that you don't have your computers from Y1 but this isn't necessarily true.
But throughout this you have the asset which simply looses its value, buying the asset was not an expense - even if it felt like one - but the loosing of value in the asset is.

If depreciation is not adequately covered in the business it will sit thinking that it has more equity than it actually does and at some point the business will have to impair the value of assets and recognize that it has less equity. The biggest problem I imagine with this is that it leads to poor business decisions - Telkom being a good case in point, who overvalued their copper network and so a reasonable return on investment was put at an inflated price and well you get the rest.

(I actually don't know how the accounting happens if a business has property liquidated by virtue of judicial liquidation or execution but the principle stands an action leads)
[As an aside at school I HATED it when we did sports clubs as a section of work, thought it was a completely pointless section designed just to irritate us. Since finishing school the accounting records I've most needed to work with - as opposed to simply read over - have all been voluntary associations]

 

[initroot]

Funny how all use depreciation instead of wear & tear, since we are dealing with tax .

 

[redarrow]

I am not a tax or accounting fundi at all - my copy of Gripping GAAP (a couple of editions back) is sitting with my brother and the last time I did any accounting was in High School - but I think you are making the mistake of thinking of depreciation as a "tax thing". It isn't a tax thing although it has obvious implications for tax. Even an enterprise that does not pay tax has depreciation.

Probably true.. but I was only really interested in the tax implications. I think my biggest misunderstanding was thinking of the assests in question as business expenses (hence the double dipping). The guy who explained the whole depreciation thing to me is an actual accountant, I think he was assuming I had far more knowledge on the matter than I really do.

Funny how all use depreciation instead of wear & tear, since we are dealing with tax .

Is there a difference?

 

[Stefanmuller]

Depreciation is an accounting entry, the purpose being expensing said asset over the duration of its estimated useful life. A computer for example is considered worthless or due for replacement after a few years so by that time it has no real future value and therefore would have been an expense. The entity can decide on whatever useful live it considers to be reasonable but because it affects the taxable income, SARS gives guidance on the depreciation rates (called wear and tear allowance for tax purposes) that would be allowed for tax purposes for different types of assets. For computers its 3 years. So for tax you are only allowed the wear and tear over 3 years. Any difference between accounting depreciation and the wear and tear rate gives rise to deferred tax.

Important to note the difference between depreciation and cash flow. It is an accounting entry and not an actual cash flow. In the previous example the net cash flow was R90 000 (R100 000 less R10 000cash paid for PC). But the net profit per the books show as R96 667.

 

[initroot]

Depreciation is an accounting entry, the purpose being expensing said asset over the duration of its estimated useful life. A computer for example is considered worthless or due for replacement after a few years so by that time it has no real future value and therefore would have been an expense. The entity can decide on whatever useful live it considers to be reasonable but because it affects the taxable income, SARS gives guidance on the depreciation rates (called wear and tear allowance for tax purposes) that would be allowed for tax purposes for different types of assets. For computers its 3 years. So for tax you are only allowed the wear and tear over 3 years. Any difference between accounting depreciation and the wear and tear rate gives rise to deferred tax.

Important to note the difference between depreciation and cash flow. It is an accounting entry and not an actual cash flow. In the previous example the net cash flow was R90 000 (R100 000 less R10 000cash paid for PC). But the net profit per the books show as R96 667.

Just to add deferred tax isn't limited to only depreciation and your wear & tear, other factors also affect it. But would fall outside scope of your question.

And there you have it. Pretty much sums it up. Got to love mybb..