If you own a small business, you need to know how to account for the depreciation of your property, plant and equipment (PPE) assets properly, and how to optimise depreciation for tax purposes. PPE are tangible long-term business assets like equipment, machinery, buildings, and vehicles – also called fixed assets.

Accountants use PPE to assess the financial efficiency your business and the South African Revenue Service (SARS) grants specific allowances to help offset PPE depreciation for businesses like yours.

How depreciation affects PPE assets

Depreciation is an accounting method that spreads the cost of an asset over its expected useful life to give you a more accurate view of its value. It is an accounting requirement that is used to account for the cost of the PPE on the balance sheet and income statement of your business every year.

When you acquire a business asset, it is recorded at cost in the balance sheet as PPE. Thereafter you must account for its depreciation as a periodic expense on your income statement, using different methods. Depreciation appears as an expense on your income statement, reducing net income, even though it doesn’t involve actual cash flow.

Depreciation will have an impact on your financial statements, tax, and profitability. You can write off a portion of the cost price of the PPE as a deduction in your income statement and in your income tax calculation.

To understand how depreciation affects your PPE, remember these key points:

• Depreciation is not a cash expense. You record the cost of the PPE over the asset’s useful life in your income statement as an expense.
  
  
• Depreciation isn’t based on when you buy the PPE, even if it is paid in instalments over time. Instead, you calculate depreciation at fixed intervals over the useful life of the asset, starting from when you begin using the asset in your business.  
  
  
• Properly accounting for depreciation in your financial statements helps you manage future cash needs. It enables you to plan for asset replacements so that you can be prepared and maybe set aside money in your business account each month.

Different methods of depreciation explained

• Straight-line depreciation
  This is the most common, simplest depreciation method, used for PPE that loses value steadily over time. It is calculated as the cost of the PPE, minus its residual value (the estimated selling price of the PPE at the end of its useful life), divided by the useful life of the PPE. Straight-line depreciation has the advantage of spreading the expense evenly over the accounting period.

• Units of production depreciation
  This method is based on how many items the PPE can produce. It’s generally used for PPE like manufacturing equipment meant to produce a certain number of units. It is calculated on the number of units produced divided by the life of the asset in units, multiplied by the cost of the asset after subtracting its residual value.

• Double declining balance depreciation
  This is used to calculate depreciation on PPE like vehicles and other assets that lose value quickly, because it represents the accelerated loss of value of certain assets more accurately than straight-line depreciation does. It is calculated at twice the straight-line depreciation rate multiplied by the book value of the asset at the beginning of the calculation period. Depreciation expenses continually decline over time as the asset becomes less productive and requires more maintenance.

Tax allowances for PPE in your small business

SARS has outlined wear-and-tear rates to help you calculate depreciation allowances for common PPE and determine how much you can deduct over time. These rates are designed to standardise how different types of assets are depreciated for tax purposes.

• Allowances for wear and tear: You can claim a tax deduction for the depreciation of assets, to help your business offset their natural decline in value due to everyday use.
  
  
• Claiming the wear and tear allowance on PPE: Depreciation directly affects the net income of your business and reduces taxable income. Depreciation reduces the accounting profit before tax (PBT) of your business. To determine taxable income, add the accounting depreciation to your PBT and deduct the wear-and-tear allowance, which reduces the taxable income of your business. This process involves several calculations and the recording of assets and depreciation in your financial statements. We strongly advise you to consult a qualified tax accountant to prepare your business tax returns.  

Consulting a professional accountant, auditor or tax professional is the easiest way to tackle depreciation and replacement planning for your PPE. If you handle the taxes and financial statements of your business on your own, keep accurate records of all your business assets, depreciation, and wear-and-tear allowances to ensure tax compliance. You must keep these records for the prescribed period of the tax assessment for that particular year.

These records include:

• Purchase receipts and invoices
• Depreciation and wear-and-tear schedules
• Asset registers
• Tax returns

Nedbank offers a complete range of services, advice and support for your small business, including professional tax advice.