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Technical notes
DEPRECIATION
- A measure of the amount of an asset used in each period
- Ignored for tax purposes – essential for profit measurement
Every asset has a finite life. In considering the expenses incurred in running a business it is important to include a proportion of the cost of each asset unless the life of the asset is exhausted in the same accounting period as that when it was acquired. Thus if an asset has a life of three years its cost might be set against income in three annual instalments or in 36 monthly instalments. The remaining life should be reconsidered frequently, so using the example above, if you reconsider the life of the asset at the end of the second year and decide that the asset has a remaining life of two years and not one, then the remaining value is depreciated over two years.
Where you decide that the depreciation is to write off the cost of the
asset over a fixed period in even instalments (even if you change your
mind as to the number of years part way through) this is “Straight
Line Depreciation”. As an alternative you may consider that the asset
never really ceases to have value to the business. Then your depreciation
may be a fixed percentage of the value brought forward from the previous
year. This is called “Reducing Balance Depreciation”. Consider
the following example:-
| Straight Line Method | Reducing Balance Method | |
| Asset Cost Depreciation rate 25% |
1,000.00 | 1,000.00 |
| Year 1 Depreciation |
250.00 |
250.00 |
| Balance of cost Year 2 Depreciation |
750.00 250.00 |
750.00 187.50 |
| Balance of cost Year 3 Depreciation |
500.00
250.00 |
562.50 140.63 |
| Balance of cost Year 4 Depreciation |
250.00
250.00 |
421.88 105.47 |
| Balance of cost Year 5 Depreciation |
- | 316.41 79.10 |
| Balance of cost Year 6 Depreciation |
237.31 59.33 |
|
| Balance of cost |
|
177.98 etc |
Where the reducing balance method is used the depreciation for a year is the fixed percentage of the balance at the end of the previous year. The choice of method is a matter of judgement for you. While the reducing balance method was once favoured, the advent of short life fashion and high technology goods has led to a preference for the straight line method.
While depreciation is useful for management accounts it is ignored by HM Revenue and Customs. If your letting business qualifies for Capital Allowances (Furnished Holiday Letting (until 06/04/2010), Industrial and Commercial buildings etc) then these may be claimed. They are effectively depreciation on a reducing balance at a rate set down by statute.
Where Capital Allowances are not available there are two alternatives
for the landlord of fully furnished residential property: Either the Renewals
Basis can be used or the landlord may claim a Wear
and Tear Allowance. The renewals basis allows the landlord to claim
as a deduction from profits the cost of replacing furnishings and fittings
etc. The wear and tear allowance allows the landlord to make a deduction
for depreciation calculated as 10% of the gross rents less certain expenses.
DISCLAIMER
© Landlords Tax Services Ltd 2008 All Rights Reserved - In an article
such as the one on this page we can only give brief general guidance and
cannot cover all situations. This guidance may not cover all your personal
circumstances and so you should not rely on it. Before taking action or
not, always do your own specific research and seek appropriate professional
advice which takes into account your personal circumstances, with the
full facts of the case and all documents to hand. Neither Maurice Patry
F.C.A. nor Landlords Tax Services Ltd can be held responsible for the
consequences of any action or the consequences of deciding not to act.