What is accounting depreciation used for? and how to manage?

Accounting depreciation is an accounting technique. It makes it possible to spread the cost of a purchase over several financial years, depending on the nature of the asset acquired, and its expected duration of use by the company. Depreciation is the reflection, in the company’s accounts, of the depreciation of an asset (wear or obsolescence), and of the natural need for renewal. It has financial, economic, fiscal, and also legal implications on the company’s situation.

What is accounting depreciation used for?

The duration of use of goods purchased by a company differs according to their nature. Certain goods such as raw materials or services are consumed in the weeks following their purchase. (a few months at most). They are recognized directly as expenses.

Others, such as real estate (machines, buildings, etc.) have a much longer period of use, which is spread over several years.

The general chart of accounts provides for the expense of these purchases to be spread over several years using the depreciation technique.

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To understand what damping is, it is necessary to differentiate:

  • the financial impact of the purchase which corresponds to the accounting recording of the payment. It is immediate. It cannot be spread over several exercises. In fact, except in special cases, purchases are paid for in full over a single financial year. The purchase will therefore have an influence on the immediate cash flow of the business.
  • the cost of the purchase, that is to say, the drop in profit which results from purchase and which can be spread (for accounting purposes) over several years thanks to depreciation.

Indeed, the depreciation rules “define” the useful life of an asset, and thus authorize the company to spread the expense of the purchase of an investment over several accounting years.

In the end, depreciation shows the share of the value that a good loses during a financial year due to time (an old machine is worth less than a new one, even in good condition), its use (wear and tear), and its aging (technical obsolescence often due to technological developments).

Accounting rules require that depreciation be recorded for each asset on the asset side of the balance sheet, in order to take its depreciation into account. The amount of the depreciation is determined according to accounting rules that it is forbidden to violate to modify the accounting result for the financial year, even if the company makes a loss.

Why depreciate fixed assets in the accounts?

The posting of an invoice for the purchase of equipment is made in a fixed asset account (debited from a class 2 account), so this accounting entry has no impact on the company’s results.

At the end of the financial year, when the accounts are drawn up, the good appears on the asset side of the balance sheet (which represents what the company owns) at its purchase value, while its use value has already lowered because of its use since the moment we bought it. It is therefore necessary to record this depreciation by showing a charge corresponding to the depreciation of the asset. This should be done at the end of each financial year as long as the asset has a non-zero book value.

The posting of a depreciation charge allows at the end of each financial year to:

  • reduce the value of fixed assets on the asset side of the balance sheet;
  • transfer the impairment loss to income statement expense. This has the consequence of reducing the result.

These regular bookings make it possible to spread the cost of acquiring an asset over several years.

Note: only fixed assets which depreciate irreversibly due to time, their use, and/or their aging are subject to accounting depreciation (machines, software, furniture, vehicles, etc.). Assets for which the depreciation has not been established or is not irreversible (land, security deposit, business assets, investments, etc.) cannot be depreciated.

How to account for depreciation expenses?

We have seen that the fixed asset to be depreciated was debited from a class 2 account. To reduce its value, a similar account will be credited with the amount of the depreciation allowance. The numbering of this account will be identical except that an “8” will be inserted in the second position.

For example, the depreciation of transport equipment will be done in account 28182. In return, an expense account will be debited to record the expense: account 6811, Depreciation allowance.

Example:

The following accounting entry records a total allocation of 8,000 euros for 4 different assets:

  • Industrial equipment for 2,000 euros (recorded in account 2154)
  • Industrial tools for 750 euros (recorded in account 2155)
  • A vehicle for 5,000 euros (recorded in account 2182)
  • Furniture for 250 euros (recorded in account 2184)

How to calculate the amount of the depreciation allowance?

Although there are several ways to calculate accounting depreciation, in this article we will only use the simplest one: straight-line depreciation.

In addition to straight-line depreciation, there are other methods of calculating the depreciation allowance: declining balance, derogatory, and exceptional over-depreciation.

Straight-line depreciation consists of distributing the purchase charge of the fixed asset on a regular basis throughout its useful life.

During the financial year during which the asset was purchased, the depreciation allowance (for the first financial year) is calculated on a pro-rata basis, in order to take into account only the number of days during which the company owned the asset. Inevitably, the depreciation allowance for the last year will also be calculated on a pro-rata basis to complete the period taken into account during the first year. For the sake of simplicity, it is possible to base the accounting year on 360 days.

How long should an asset be depreciated?

In accounting, the depreciation of an asset begins on the day it is operational. Regarding the duration of depreciation, the accountant must estimate the real life of the purchased good, and the tax administration uses an indicative scale which is best not to deviate too far. When justified, a controller will consider acceptable a deviation of the order of 20%.

In general, the most commonly accepted amortization periods by the tax authorities are:

  • Commercial buildings: between 20 and 50 years old,
  • Office buildings: 25 years,
  • Industrial buildings: 20 years,
  • Fixtures and fittings: between 10 and 20 years,
  • Furniture: 10 years,
  • Materials: between 7 and 10 years old,
  • Office equipment: between 5 and 10 years,
  • Tools: between 5 and 10 years,
  • Patents: 5 years,
  • Motor vehicles: between 4 and 5 years,
  • Computers: 3 years.

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