If you are an individual who is associated with the sector of accounting in any way, you must have heard about the accounting terminology ‘depreciation’. This is known to explain the cost involved in buying an asset and then using this asset for a specific reason for a reasonable period of time. Moreover, the asset must be used for business purposes. As a professional in the accounting field, and a beginner, you would need to know the basics of depreciation. This comprehensive guide has got you covered here with an explanation of what is depreciation, how to work out depreciation, and how to record it.
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What is Depreciation?
Depreciation is known to be an accounting mechanism and its main purpose is to focus on spreading the value of an asset. Such an asset is used for business and is used for a certain period of time in the business. With the help of depreciation, you can even reduce the value of the assets on the balance sheet. This reduction is due to the fact that the buying price of an asset is usually less than the reselling price. You do not get the same amount at the time of reselling an asset as it was at the buying point.
This also works to evident the day-to-day running cost in a business when it is related to the profit and loss account. It is imperative to understand here that the reduction of the value of an asset is because the business has used the parts of an asset over a period of time to make profits by selling the products. The profits earned through the selling period can be considered good compensation for the value reduction of the asset.
How to Work Out Depreciation?
In the UK there are two different ways to work out depreciation commonly. These are listed and explained in the following:
1- Reducing Balance Depreciation
Reducing balance depreciation is a method that is commonly used in the UK to calculate the depreciation of an asset. Businesses prefer to use this method according to certain circumstances. This is because it is the most suitable when an asset is way more valuable in the early stage of life, however, the value of the same asset starts to go down as the life of the asset progresses.
We will take the example of a computer that a business has bought for £1,000. The projected life of the computer is four years. If you want to depreciate at 20 per cent on reducing balance, you will have to multiply the figure £1,000 by 20 per cent and you will get £200. Minus the depreciation cost in the next year from the original value.
2- Straight Line Depreciation
The straight-line method is considered to be easier in comparison to reducing balance depreciation. You simply have to figure out the original value of the asset and then divide it by the number of usage years. Make sure the years of usage purely belong to the business purpose for an accurate calculation. This is a very simple method of calculation. The results are even posted on a yearly basis on the profit and loss account.
How to Record the Details of Depreciation Calculations?
You must be wondering by now about recording the details of the depreciation calculations. Well, there are several options of online software that can be used for this purpose. However, you will have to be considerate about choosing the software that is suitable according to your specific needs.
The Bottom Line
Now that we have gathered a fair amount of information about how to work out depreciation in the UK, we can bring the discussion towards wrapping up. It is important to know the value of your assets as your sets are progressing in their life. As this can reduce the value of assets and you will require to make the records accordingly. We hope these few minutes of reading will help you better understand how to work out depreciation in the UK.
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Disclaimer: All the information provided in this article on how to work out depreciation in the UK, including all the texts and graphics, is general in nature. It does not intend to disregard any of the professional advice.