Depreciation for Australian Businesses - The What, When and How.

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Depreciation is the magic wand used by your tax accountant to turn your positive cashflow investment unit into a negatively geared, loss making tax deduction in the eyes of the ATO.

At the same time it may be the annoying concept which is preventing your PTY Ltd company from deducting the whole amount of the new software package or vehicle which was recently purchased.

What is depreciation?

Depreciation or 'capital allowance' is how the decline in value of assets is recorded.

This comes about when a purchase made by you or your business is not allowed to be fully deducted under s 8-1 of ITAA97 as it is classified as a capital purchase instead of an expense.

E.g. if you wanted to get into the business of hospitality and went and bought a coffee machine to get started, this purchase would be capital in nature and the coffee machine would be considered a depreciating asset.

Instead of wholly deducting the coffee machine, the coffee machine will be deducted over multiple years.

Note however that there are some specific items excluded from being depreciating assets such as trading stock and land.

When is depreciation used?  

When a purchase is capitalized and depreciated instead of expensed, depends on whether you are a small business entity (SBE) with under $10m of turnover or not according to Australian tax law.

Small business entity (SBE) - Has the option to pool all assets purchased for over $1,000 into a small business asset pool which is depreciated favorably at the end of each financial year as a whole.

Businesses with over $10m turnover - Purchases under $300 can be immediately expensed, purchases under $1,000 can be added to a low value pool and most other assets are depreciated using prime cost or diminishing value method over multiple years.

Essentially all assets purchased are either depreciated instantly, added to a depreciation pool or depreciated individually depending on value thresholds provided by the Australian taxation office.

** Note: Covid has changed these numbers and thresholds in the interim but they will revert back in January 2021

How is depreciation Calculated?

SBE

Using the simplified depreciation rules:

- Assets over $1,000 - Added to the small business asset pool and depreciated at 15% the first year and 30% every year after.

- Assets under $1,000 - Can be immediately expensed, no need to depreciate.

However if the business decides not to use the simplified depreciation rules then they will have to depreciate each asset using the prime cost or diminishing value method, which requires a lot more record keeping and calculations.

Businesses with over $10m turnover

- Assets under $300 - Can be immediately expensed, no need to depreciate.

- Assets under $1,000 - Added to low value asset pool and depreciated at 18.75% first year and 37.5% every year after.

- Costs associated with software development - Added to software development pool and depreciated at 0% the first year 30% for the next 3 years and 10% on the 5th year.

- All other asset purchases - Depreciated using the prime cost or diminishing value methods. Prime cost method provides a steady depreciation while the diminishing value method allows for larger deductions early on that fade out towards the end of the assets effective life.

Still have no idea what is going on with depreciation?

If you are unsure about the specifics of depreciation and how it effects your financial statements and tax position, reach out to CTK Accounting to get a registered CPA and Tax agents opinion on your position, goals and trajectory to make sure you come out on top.

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