Difference Between Income Statement And Balance Sheet And Cash Flow 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. Because most assets are capitalized on the balance sheet, in financial statements, “depreciation expense” is reported as an expense on the income statement.

There is much debate in accounting circles about depreciation, as it is difficult to determine what would constitute a “reasonable estimate”. Furthermore, until recently it was accepted that land and buildings are not depreciated, but appreciated. Recent developments, however, have now suggested building depreciation.

Tax “write-offs” on assets further complicate matters, since the statutory rates for tax credits are higher than the depreciation rates, thus creating discrepancies between the tax values ​​and the book values ​​of the assets.

I argue that asset accounting can only be done thoroughly, with the help of a discerning accountant. The accountant’s expertise in fixed asset registers, accounting standards and a solid understanding of tax legislation is of key importance.

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

The rate at which companies would depreciate their assets coincides with the economic life of the asset. Thus, the accepted economic life is the useful life for 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 businesses typically upgrade every 6 to 12 months are used for 3 to 4 years!

Therefore, if the useful life method is applied, in non-profit organizations the asset could have a depreciation rate of only 2%. Accounting standards expect fair presentation. Depreciation rates for non-profit and other social organizations should be applied carefully.

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

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