An organization’s long-term or fixed assets such as equipment and machines constitute a significant portion of its balance sheet. Depreciation of an asset entails spreading its cost over the span of several years. Adequate accounting depreciation procedures are required by an organization to ensure accurate financial data reporting.
What is Financial Depreciation?
Financial depreciation comprises of a set of accounting rules that need to be followed by an organization in order to depreciate its fixed assets over their useful life. The term useful life can be defined as the time period during which the assets are expected to be functional or useful.
The international financial reporting standards (IFRS) and Generally Accepted Accounting Principles (GAAP) require an organization to depreciate its fixed assets using a straight line method of depreciation or an accelerated depreciation method. In a straight line method, the depreciation expense of a fixed asset remains the same every year, whereas, in an accelerated depreciation method, the depreciation expense varies on an annual basis.
Benefits of Financial Depreciation
Because fixed assets usually require sizeable investments, financial depreciation is essential for an organization’s financial reporting and accounting procedures.
What is Tax depreciation?
Tax Depreciation can be defined as a legal deduction that is available to owners of income-generating properties. It is one of the biggest deductions for any taxpayer (especially business owners) that enables them to save money on their taxes and maximize income at the close of the financial year. Depending on the size, location, the industry in which an organization operates and the number of fixed assets owned by an organization, tax depreciation procedures may vary.
The Internal Revenue Service (IRS) regulations usually require a company to depreciate its fixed assets on the basis of its useful life and the type of asset. A tax depreciation table is often provided to accountants which guide them on how to fulfil the fiscal regulations. Accelerated methods of depreciation are mostly preferred by tax authorities.
Tax Depreciation is one of the biggest deductions for any taxpayer (especially business owners) that enables them to save money on their taxes and maximize income at the close of the financial year.
In order for an organization to be eligible for a tax depreciation schedule, a specific set of standards needs to be met, including;
• Ownership of the Asset: The asset or the property is owned by you.
• The Usage of the Asset: The asset is used in a business or for the purpose of producing income.
• The Useful Life of the Asset: The property has a determinable useful life of more than a year.
Tax Depreciation vs. Financial Depreciation
Financial Depreciation is different from tax depreciation. Nonetheless, financial depreciation rules have a significant impact on how an organization reports its financial statements and its accounting information.
Simply put, financial depreciation can be defined as the loss in the value of an asset due to its usage, whereas, tax depreciation is an annual allowance for the deterioration, obsolescence and wear and tear of the property (tangible).