What is depreciation?

New machinery can be a very large investment for a company. So that the big investment won’t distort accounting by showing one very large investment for one accounting period and nothing else for the other periods, companies are advised to divide the price throughout its service life. All companies required to keep accounting and who have consumable property are obliged to reduce their acquisition cost during their lifetime and to draw up a depreciation plan. Depreciation is carried out once the purchase is in company use, not at the time of purchase.

Depreciation is done like this: The new machine or equipment is recorded in bookkeeping into the company’s balance sheet, because the balance sheet measures the value of a company’s assets and liabilities at a given time. Depreciation is done from the acquisition cost of the property marked in the balance sheet in accordance to a pre-defined plan. Once depreciation has been done, the value of the property will depreciate in the balance sheet and the depreciated amount will be transferred to the company’s expenses. The pre-defined depreciation plan is usually done for the period that the property is expected to be in use. In addition to machinery, equipment, computers and cars, depreciation can be made for a company’s IT system for example if it is expected to generate income for the company. However, the company must calculate how much income they are expecting to make and this projection has to be kept along with all accounting materials. The so-called activated amount cannot be greater than the cumulative margin.

Note: The depreciation amount for any given property can be deducted for tax purposes if it is no more than 25% of the cost of acquisition that is marked in the balance sheet.

Pre-defined depreciation of the same amount is made yearly in accordance with the depreciation plan. The acquisition cost of the investment has to include purchase costs such as freight, import and installation expenditure. Any discounts must also be taken into account.