ABC of Accounting: Understanding your Assets and Depreciation

understanding assets and depreciation

In the world of accounting you may hear words like tangible, intangible, fixed, current, all these terms can precede the word, asset. But what do they mean?

For small businesses trying to understand the complexities of accounting we have explained in our latest ABC of Accounting blog the meaning of these and how they are treated within your business and the impact within your accounting system.

Tangible or Intangible

In business Tangible Assets, consist of assets that have a physical existence, for example Inventory, motor vehicles, plant and machinery, office furniture and fittings, computer equipment.

Intangible assets consist of assets such as goodwill, computer software, IP (intellectual property), these assets cannot be seen or touched, however, they still play a part in the success of the business and will need to be depreciated or in some cases re-valued at your year end.

Assets of any business can be depreciated over a fixed period of time. The life span of the asset can vary from asset type, for example motor vehicles maybe over a period of five years and computer equipment over three years.

Once you’ve established which main group they appear in, these can then be split into fixed or also referred to as non current assets and current assets.

Current and fixed assets

Current assets consist of Inventory, cash and bank balances, accounts receivable so, all amounts owed to you by your customers. Prepaid expenses, anything that you have paid for but has yet to happen.

Fixed assets relate to items purchased for the business such as motor vehicles, plant and equipment, furniture, computer equipment.

Within accounting procedures for an item to become a fixed asset and not just expensed within the financial year it was purchased the value of the item would normally need to be the equivalent or exceed £500, this amount can vary depending on company policy. It can also take the form of several items being purchased of a smaller value for example work being carried out to fixtures and fittings which individually don’t add up to £500 but collectively do.

Depreciation

If you have purchased an item that you classify as a fixed asset then this item can be depreciated over a period of time, this being the normal life expectancy of the item purchased. For example, a laptop might have a life expectancy of three years whereby a vehicle will be longer, normally five years.

The item can be depreciated to zero or to a negligible amount such as a scrap value or NBV (net book value), this being the value you anticipate selling for once the item is fully depreciated. The amount of the depreciation can be calculated as follows:-

A computer laptop is purchased at the net value of £900.00 and has a life expectancy of say three years so, £900 / 36 = £25.00 depreciation per month. A journal of £25.00 would then be created within your accounting system debiting your Profit & Loss account with this amount each month and crediting your Depreciation account. You may also wish to place a NBV (net book value) against this item this is sometimes referred to as a scrap value as after the item has been fully depreciated you may still get something for it if you attempted to sell it. In which case you would deduct this amount prior to calculating the depreciation figure, for example £900 – £50 (NBV) = £850.00 / 36 = £23.61 depreciation per month.

In the majority of online accounting software including Reviso a Fixed Asset module is available which enables you to add your assets, categorize them into the relevant type and timescale/term the amount of depreciation, this will then do all the calculations for you and post to the relevant accounts within your chart of accounts.