Is My Depreciation Method Correct?

[jameslp]

I’m currently looking at my method of depreciation. I am using the straight-line method over 3 years for most equipment (computers, camera bodies, etc.) with a residual value of £1.00 for computers (pretty much scrap) and a few hundred for the camera bodies.

However in the case of camera lenses; they generally keep their value for much longer than other types of equipment and we should probably depreciate them over 5 years. In addition I was going to have a much higher residual value, e.g. a £1000 lens could still be worth £500 in 5 years time (and even well beyond 5 years). So should I reduce its value by £100 each year for 5 years and leave it with a residual value of £500 at which point I’ll either keep hold of it or sell it. Is my strategy correct?

Thanks,
James

 

[Philip Hoyle]

Remember that "depreciating" assets isn't primarily for accounting for the change in their value over time. It's purpose is for spreading the cost of the asset over its useful life.

Rather than thinking about what each asset will be worth, you should really be thinking about how long each asset will be usefully employed within the business. To take your lens example, you'd write half the cost over 3 years and then not write anything else off so whilst it was still in use after year 3, there'd be nothing in the accounts to account for its continued useage. If you had it in active use for 10 years, you should really be writing off the 50% reduction in value over 10 years, not just 3.

I think, to be pedantic, instead of working on a 3 year write down and thinking of the value at the end of year 3, you should be working on the anticipated useful life of the asset - i.e. how long you realistically expect to continue to use each item and the value when you realistically expect to scrap or sell it. For example, it's patently wrong if you base your depreciation for lenses on 3 years, but in fact you have no intention of selling them at the end of year 3.

All that said, most businesses won't go into anywhere near such detailed thinking and calculations as you have done. Most will just apply, say 25% p.a. reducing balance on everything and not give it a moment's more thought! So, your proposal is probably a lot more accurate than most businesses anyway - I'm only commentating because you clearly want to do things properly, and I think you can be a little more realistic to show the cost over the real useful life to your business rather than trying to stick to arbitrary selling values at times you're probably unlikely to sell!

 

[jameslp]

Hi Philip,

Thanks so much for your excellent reply; it's really helpful. You're right, I really do want to do things properly and it's sometimes so hard to find the information needed to achieve that. What you've explained really makes sense; I'll judge each piece of equipment and allocate an appropriate term (the anticipated useful life) and residual value.

A couple of further questions if I may- what is the consequence of estimating a useful life of, for example, 4 years but the business continues to use it for an additional 2 years (unexpectedly)? Also, how important is it to accurately estimate the residual value?

Am I right in thinking that I want to estimate these values (depreciation term & residual value) as best I can so that I get a realistic picture of how my business is performing, as opposed to there being a law I need to adhere to?

Many thanks again,
James

 

[jameslp]

Another query on this - if I was to apply depreciation on assets just once a year (at year end); what do I do about assets that were bought just a week or even a day before? Can I simplify things by depreciating a year off these items?

 

[Jenni384]

Another query on this - if I was to apply depreciation on assets just once a year (at year end); what do I do about assets that were bought just a week or even a day before? Can I simplify things by depreciating a year off these items?

Yes. It's quite normal to depreciate fully in the year of purchase and not at all in the year of disposal.

 

[jameslp]

Yes. It's quite normal to depreciate fully in the year of purchase and not at all in the year of disposal.

Thanks Jenni - I do love it when there's a simple answer!!

 

[Jenni384]

Thanks Jenni - I do love it when there's a simple answer!!

You're welcome

In accountancy it does happen - sometimes!

 

[QuickHomeBuyers]

Ive got a question after reading this,

Lets say I got a laptop. Now how long do I have to use it before I can dispose it off?

And whats the best way to dispose off an item? Recycling perhaps?

 

[Jenni384]

Now how long do I have to use it before I can dispose it off?

And whats the best way to dispose off an item? Recycling perhaps?

You use it for as long as you need. Some laptops last only a year (or less!) and others can last for a good few years, it depends on the usage. There's no rule I know of that says 'you have to keep it for x years before disposal'.

Technically, if you expect something to last under a year, it therefore doesn't fulfil the definition of a fixed asset, so it would just go through the P&L as expensed equipment.

I think recycling is preferable to the bin. If a disposal is made by way of giving it to your child (for example) this would need to have a market value attached to it at the date of disposal, just as if you sold it to a third party, and this value reflected in the accounts.

I only logged on to my PC to retrive my Sky PIN....... I'm off for a cup of tea now

 

[QuickHomeBuyers]

You use it for as long as you need. Some laptops last only a year (or less!) and others can last for a good few years, it depends on the usage. There's no rule I know of that says 'you have to keep it for x years before disposal'.

Technically, if you expect something to last under a year, it therefore doesn't fulfil the definition of a fixed asset, so it would just go through the P&L as expensed equipment.

I think recycling is preferable to the bin. If a disposal is made by way of giving it to your child (for example) this would need to have a market value attached to it at the date of disposal, just as if you sold it to a third party, and this value reflected in the accounts.

I only logged on to my PC to retrive my Sky PIN....... I'm off for a cup of tea now

This is my definition of recycling. Not that I have any kids (none that I am aware of anyway). lOl

Its good to share a lovely cuppa.