Depreciation refers to a decrease in the sale value of an item over time. Business laws allow a business to reduce its tax liability by deducting the value lost from its revenues.
Every business needs some assets to operate. These include, computers, furniture, motor vehicles and equipment. Generally, assets lose value over time due to use, wear and tear. Eventually, they have to be replaced with new items. Most businesses replace their assets when they get too old, or damaged.
Deduction of a depreciation expense helps the business build a cash reserve, which it can use to replace the asset after its useful life.
A company’s depreciation expense increases its operating costs during the accounting period. This reduces the gross profits of the company (which often forms the basis for taxing the business).
for instance, let’s assume my business earned N20 million between 1st January 2020 and 31st December 2020. Ordinarily, our companies income tax for the year would be about 30% of that sum. However, if all my business assets lost 25% in value during the year, I can deduct that loss from my gross profits. This reduces the amount of taxes owed by my company.
Using depreciation properly can help your company earn revenue from the business assets, while expensing a portion of its cost each year the asset is being used.
ARE ALL ASSETS AFFECTED BY DEPRECIATION?
Businesses cannot depreciate all their assets. For an asset to be depreciable, it must lose value over time. However, where the asset appreciates in value over time, it won’t qualify for deduction. For instance, land does not usually qualify for deductibility, unless there has been a fall in property values within the period.
Depreciation applies to fixed assets. These are tangible pieces of property or equipment which it uses to generate income. Items with a short lifespan do not qualify for depreciation. They can however be written off as business expenses in that year.
For example, office supplies are expense items while a printer, that you would use for a longer period, is a fixed asset that depreciates every year.
Not all fixed assets are depreciable.
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You cannot depreciate property for personal use and assets held for investment. These include cash in hand, receivables and investments such as stocks and bonds.
Notable Exceptions to the Rule
If you’ve made improvements to your rented property, you’re eligible to depreciate them.
Intangible property such as patents, copyrights, computer software can be depreciated. However, you need to speak with a trained tax consultant in order to determine how much you can deduct.