What is depreciation? And why it's important.

When you first start your own business, calculating depreciation can seem impossibly complex – but getting it right has real business benefits. Find out more about the ins and outs of depreciation.

Depreciation is what happens when business assets lose value over time.
It’s an often-forgotten cost of doing business – but it shouldn’t be. Here’s why depreciation is so important:

• It costs you money - Depreciation accounting involves working out how much value your assets lose each year, so it can be listed as a loss and subtracted from your revenue.
• It can reduce your tax bill - Because depreciation is a business cost, it can lower your tax bill – so it’s important to know how much value you’re losing each year.
• It affects the value of your business - If major business assets lose value, the overall value of your business is reduced. Inaccurate tracking could lead to overestimating your business value, which makes it harder to secure finance.

The ins and outs of depreciation

Usually, only long-term or fixed assets can be depreciated, while consumable products aren’t included.

You also need to estimate the item’s lifespan and choose a method to calculate how its value declines over time.

Common methods include:

• Straight line depreciation: the asset depreciates by the same amount each year, eventually reaching zero value.
• Diminishing value depreciation: the value declines by a higher percentage in the first few years, then the rate of depreciation slows.
• Units of production depreciation: the lifespan is calculated by the value delivered, not the time spent using the asset. For example, a business vehicle’s depreciation might be measured in kilometres travelled rather than age.

Accounting for depreciation in your business

When you’re just starting out, calculating depreciation can seem overwhelmingly complex. But, because it can lower your costs and help you track your business value, it’s worth making the effort.
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If you’re not sure where to start, get help from our expert accounting team now.

The following content was originally published by Xero in this article. We have updated some of it for our readers.