Accounting Depreciation Versus Tax Depreciation for Assets
Many accountants prefer to maintain a single fixed asset register for their clients’ businesses. And, since tax depreciation tends to be much more aggressive than accounting depreciation, basing fixed asset registers solely on tax rules seems like a great choice.
For example, in Australia, the Tax Act permits the immediate deduction of 100% of the value of some assets. Other assets can be depreciated aggressively in pools and by taking advantage of rules like Backing Business Investment accelerated depreciation.
Depreciating assets as aggressively as possible makes great sense for tax, but using these same rules for accounting has some serious downsides.
For accounting, your fixed asset register should reflect the value of an asset at any time during its useful life. And the ‘cost’ of the asset should be spread across the asset’s useful life – allowing you to reflect the cost to use that asset to produce income in any given period.
But, aside from distorting the true value of assets to a business, depreciating too aggressively reduces the value of those assets on the balance sheet as well as reducing profits on the P&L – therefore undervaluing the business. This can have significant impacts on a business’ ability to borrow, meet banking loan covenants, and sell the business at a fair value.
Keeping separate asset registers for tax and accounting ensures you can maximise taxable deductions for your client and maximise the value of the business on the balance sheet.
To see what we mean here, let’s consider a really simple example.
XYZ Gym Group decides to open a new gym on 01 July, 2019. They’ve leased a premises, purchased $250,000 worth of equipment and secured some foundation memberships.
As XYZ is a small business entity (SBE) for tax purposes and, as all of the equipment purchases were less than $30,000 each, XYZ is entitled to claim 100% of these expenses as a tax deduction in their first year. So far, so good!
Let’s have a look at the financial statements for 2019/20.
The first thing that stands out is that XYZ ends up with a taxable loss of $192,082 carried forward for the year. But, since they’ve used tax depreciation rules only, XYZ ends up with no capitalised assets on the balance sheet. As they have liabilities in the form of creditors, GST payable, bank loans and loans from the owner, they end up with negative equity on the balance sheet.
This will have a significant impact on XYZ should they try to go to the bank to borrow, to open a second gym or to acquire more equipment for the existing gym.
What’s the alternative? The typical useful life for gym equipment is 10 years. So, from an accounting perspective, XYZ could depreciate these assets using the prime cost (straight line) method over 10 years.
Under this scenario, XYZ would depreciate 10% of the value of the equipment in 2019-20, leaving $225,000 worth of capitalised assets on the balance sheet and $25,000 in depreciation expenses on the P&L.
The result? XYZ ends the year with positive equity and a small profit for the year. This is both a more accurate reflection of the true value of the business, and puts XYZ on more solid footing with current and future creditors.
XYZ still has a taxable loss of $192,082 carried forward for the year, but has a much more positive case to present to a bank or a leasing company should they need to borrow for more equipment or to expand the business. Win-win.
Hopefully, it’s pretty clear from this example that your approach to depreciation for tax and accounting can have significant impacts on your clients’ businesses.
Wouldn’t it be great if there was an easy way to manage tax and accounting depreciation side by side?
AssetAccountant™ makes it easy to define the tax and accounting treatment of all of your fixed assets and provides a complete range of capital allowance depreciation methods for tax purposes. These range from simple prime cost and diminishing value methods, through to Division 43, Luxury Motor Vehicle caps, Blackhole Expenditure and the new Backing Business Investment accelerated depreciation rules.
AssetAccountant™ automates treatment of Small Business pools, Low Value pools and Software pools, and will even recommend which assets are eligible for transfer to these pools.
All depreciation calculations are generated for you, and journals can be posted automatically to QuickBooks Online.
Our powerful import system makes the transition from Excel or other platforms easy – you can be up and running in literally less than a minute.
AssetAccountant™ can save you significant time in managing fixed assets, while giving you the confidence that you’re optimising depreciation for both tax and accounts.