Just about every company tracks assets, from laptops to equipment to company vehicles. And many assets actually lose value, or depreciate, over time.
For some investments, asset depreciation can be claimed on your company’s taxes to reduce tax responsibility. That’s one of the reasons why it’s so important to not only keep track of where your assets are located, but also what condition they’re in and how their value has changed year by year.
This article will clearly define asset depreciation and then help you learn how to record a depreciation expense. Finally, we’ll review the three most common methods of calculating asset depreciation.
What is asset depreciation?
Asset depreciation occurs when your company’s investments lose value over time—until eventually, there’s no value left. Just about anything can depreciate, from computers to buildings to machinery.
While most assets do depreciate, there are a few exceptions. One big example? Land value usually increases over time, even as the structures on it depreciate.
Related: What are fixed assets?
Why does asset depreciation matter?
There are a variety of reasons why asset depreciation matters so much. In fact, understanding asset depreciation can help you accurately track your business’s financials in several key ways:
1. Prepare more accurate taxes
One reason asset depreciation is so important to businesses is that it allows companies to review how their assets have depreciated every year, then claim those losses on their taxes.
Many purchases, like a warehouse or a fleet of electric vehicles or even a new laptop, cannot simply be “written off” as expenses. Instead, companies are required to report depreciation on these investments year after year.
Come tax season, these depreciating assets are carefully counted against your company’s profits.
2. Understand true business costs
If your company isn’t keeping track of asset depreciation, you might not have a full picture of the cost of running your business. You may think an operation is profitable—until you realize, for example, that the machinery you rely on to run your business will eventually need to be replaced.
The same goes for high-value medical equipment, chic office furniture, and delivery drones. These investments won’t last forever, and keeping track of their dwindling value can help you both understand your true costs and recoup some of that loss through a lower tax bill.
3. Keep an eye on assets’ useful lives
By tracking asset depreciation, you won’t just be tracking your investments’ value, but their condition, too. And when you’re keeping a close eye on the condition of your assets, you’ll be more likely to schedule the preventative and routine maintenance required to keep your investments in tip-top shape.
Types of depreciation
Asset depreciation isn’t guesswork. There are rules and regulations about how to calculate depreciation, and it’s essential your business complies with them. A good accountant can help ensure your business properly claims depreciation. They’ll likely advise you to use one of these three ways to measure and report depreciation:
1. Straight-line depreciation
Straight-line depreciation is the most straightforward method of depreciation. Your accountant will assume the same percentage of depreciation on an asset every year until the item’s value hits zero.
For example, if an asset has a useful life of 20 years, you’d assume a straight-line depreciation of 5% a year over the 20 years.
The formula for straight-line depreciation is:
(Asset Cost – Residual Value) / Useful Life
2. Units of production depreciation
This method of depreciation measures value based on work performed instead of time passed. This is especially helpful for assets that take on lots of wear and tear, like machinery.
Calculating this method of depreciation is a two-step process. To begin, you’ll need to figure out the per-unit depreciation.
(Asset Cost – Residual Value) / Useful Life in Units of Production
Next, you’ll figure out the total depreciation based on units produced.
Per Unit Depreciation x Units Produced
3. Double-declining depreciation
This form of depreciation is used when an asset loses more value at the beginning of its life. This is a great way to measure depreciation for assets like cars, which notoriously lose tons of value the moment they’re driven off the lot.
To calculate double-declining depreciation, use this formula:
2 x Straight Line Depreciation Rate x “Value” at Start of Fiscal Year
How to record depreciation
Your accountant likely uses a document, spreadsheet, or accounting software to track the depreciation of your assets over time.
Regardless of how you record depreciation, staying organized is essential. And getting your assets organized often starts with adopting an effective inventory management system.
Inventory management software for asset tracking
By choosing software or an app as your inventory management system, you’ll instantly make tracking your assets’ whereabouts, value, and condition that much easier.
An inventory app such as Sortly allows you to record how much you paid for an item, what condition it’s in, and what it’s worth now. With all that information, you can quickly generate an asset checklist.
And that asset checklist can be used to annually review, calculate, and audit depreciation, saving both you and your accounting team tons of time.
Experience the simplest inventory management software.
Sortly is a top-rated inventory management software solution designed to make running your business a breeze. With Sortly, you’ll quickly create a visual dashboard that displays every asset in your company’s inventory. Then, you can upload robust item details, including value, condition, and method of depreciation, to every asset.
When tax season rolls around, simply generate a report of all your depreciating assets and any other details that matter to your company.
Sortly also offers a host of other stress-saving features, like barcode and QR code scanning, low stock alerts, and more.
Ready to get organized? Try Sortly totally free for two weeks!