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Depreciation - Useful Life, or Economic Life

Sean Goss

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

Many debates on depreciation are continuing in accounting circles, since it is difficult to establish what would constitute a “reasonable estimate". It was furthermore accepted, until recently, that land and buildings cannot depreciate, but appreciates. Recent developments, however, have now proposed depreciation on buildings.

Tax “write-offs", on assets complicates matters further, since prescribed statutory rates for tax deductions are higher than depreciation rates, thus creating variances between tax values and book values of assets.

It is my contention that asset accounting can only be performed thoroughly, with the assistance of an astute accountant. The accountants expertise, on fixed asset registers, accounting standards and firm grasp of tax legislation is vital.

Whereas tax writes offs on assets are higher, the trend in accounting is to depreciate assets in terms of its useful life, and not its economic life. The prescribed rate for a computer in tax would be three years or 33, 3%. (depending on the tax regime of the country). But a business could only use it for 6months and sell it as a scrap. This 100% provision for depreciation, as useful life, should be factored in. Office furniture could be utilized for 5 years, and then scrapped, but tax rates could prescribe four years, for a tax write off!

The rate that businesses would depreciate their assets at coincides with the economic life of an asset. So accepted economic life is useful life for business assets. In not-for-profit organizations and other community establishments, such as churches etc. the picture becomes very confusing. Churches will retain assets such as furniture for up to 40 years. Even computers that businesses normally upgrade from 6 to 12 months are used for 3 to 4 years!

So if the useful life method is applied, in not-for-profits , assets could have a depreciation rate as low as 2%. Accounting standards expect fair presentation. Depreciation rates, for not-for-profits and other community organizations, should be carefully applied.

No one expects a business owner or director, of a Not-for- Profit Organization to understand these concepts, just to ensure that at the very least, a proper asset accounting system is in place.

Accounting and finance related queries can be addressed, on our website. Feel free to visit our site by clicking on the url below.

Sean Goss



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