# How Depreciation is Calculated

## Depreciation spreads the costs of fixed assets over their forecast working life. Capital allowances replace depreciation for tax relief.

### What Does Depreciation Do

Cost less depreciation describes net book value. That in turn describes the value of the residual working life of a fixed asset, not a value that the asset would be expected to achieve in the event of a sale. That is a very important difference when it comes to assessing the value of balance sheet equity.

When producing profit and loss, balance sheet, cash flow and other business foreccasts using Figurewizard, depreciation and net asset values are automatically calculated and applied to them and the calculator / planners with no further intervention from a user apart from their projected annual figures.

### Depreciation and VAT for Company Cars

Depreciation is always charged to the cost of the asset excluding VAT. The one exception to this is company cars, which are costed including VAT. This is because unlike other assets, the VAT for cars cannot be reclaimed as input tax.

As a result, the values of the acquisition or sale of company cars are always entered into Figurewizard including VAT.

### Calculating Depreciation

The three methods to depreciating fixed assets are – Straight Line, Reducing Balance or Salvage Value. As straight line depreciation is the most prudent approach for profits and cash flow planning this is the method applied to all Figurewizard forecasts.

### Straight Line Depreciation

Take for example a fixed asset costing £5,000 (excluding VAT) to be straight line depreciated at 20% p.a. The rate of depreciation is applied to the original cost each year.

 Balance B/Fwd Depreciation Balance C/Fwd 5,000 1,000 4,000 4,000 1,000 3,000 3,000 1,000 2,000

The net book value of the fixed asset will therefore be depreciated to zero in five years. As this is the most prudent approach to depreciation it is the one used for Figurewizard forecasts.

### Reducing Balance Depreciation

Using the example of a £5,000 fixed asset, the 20% rate of depreciation is applied to the balance B/Fwd from the previous year; not to the original cost.

 Balance B/Fwd Depreciation Balance C/Fwd 5,000 1,000 4,000 4,000 800 3,200 3,200 640 2,560

In the case of reducing balance depreciation, unless or until the asset is disposed off the net book value of the asset will continue to be reduced indefinitely.

### Salvage Value Depreciation

This can be done by either the straight line or reducing balance method. The only difference will be that the salvage value for the asset is first deducted from its cost. If you elect to apply a salvage value of £500 to the example above, the opening value to be depreciated will be £4,500.

### Depreciation and Corporation Tax

In the UK HMRC does not recognise depreciation as a tax deductible overhead. First year allowances (FYA) and capital allowances on residual values after FYA has been deducted are substituted when calculating the taxable profit.

FYA and capital allowances will  vary depending on the nature of the asset.

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