Cash Difference Between Balance Sheet And Statement Of Cash Flows Depreciation – Useful Life, Or Economic Life

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Depreciation – Useful Life, Or Economic Life

Depreciation is the definition in accounting for a reasonable estimate, in monetary terms, of the depreciation of an asset over a period of time. Since most assets are capitalized on the balance sheet, financial statements show “depreciation expense” as an expense on the income statement.

Much debate about depreciation continues in accounting circles, as it is difficult to determine what constitutes a “reasonable estimate.” Furthermore, until recently it was accepted that land and buildings could not be depreciated, but appreciated. Recent developments, however, now suggest building depreciation.

Tax “write-offs” of assets further complicate matters, as the statutory tax relief rates are higher than the depreciation rates, which creates discrepancies between the tax value and the book value of the assets.

I submit that asset accounting can only be done thoroughly with the help of a shrewd accountant. Accountants’ expertise in fixed asset registers, accounting standards and a solid understanding of tax legislation is essential.

While the tax write-offs of assets are higher, the trend in accounting is to depreciate assets based on their useful life rather than their economic life. The prescribed tax rate for a computer would be three years or 33.3%. (depending on the tax regime in the country). But the company can only use it for 6 months and sell it as scrap. This 100% provision for depreciation as a lifetime should be considered. You could use the office furniture for 5 years and then scrap it, but the tax rates could dictate four years to write off the tax!

The rate at which companies would depreciate their assets coincides with the asset’s economic life. So the accepted economic life is the life of business assets.

In non-profit organizations and other community institutions such as churches, etc., the picture becomes very confusing. Churches will keep assets such as furniture for up to 40 years. Even computers that companies typically upgrade every 6 to 12 months are used for 3 to 4 years!

Therefore, if the useful life method is used, assets in non-profit organizations could have a depreciation rate of only 2%. Accounting standards expect fair presentation. Depreciation rates for nonprofits and other community organizations should be used with caution.

No one expects a business owner or nonprofit director to understand these concepts, just to ensure that at least an adequate asset accounting system is in place.

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