Capital Allowances & Depreciation (Sole Trader/Partnership)
Discussion
In a sole trader / partnership do you HAVE to charge depreciation to the accounts in order to claim capital allowances, or can you claim CA's and not bother with depreciation at all.
I can't see the point in charging depreciation, when in reality all it does is sit as negative Retained Earnings to reduce the value of Capital invested.
What am I missing?
Simon
I can't see the point in charging depreciation, when in reality all it does is sit as negative Retained Earnings to reduce the value of Capital invested.
What am I missing?
Simon
Depreciation is an "Accounting" charge and is designed to reflect the fact that Fixed Assets wear out over time and this fact needs to be accounted for.
It is required under Accounting Standards and Financial Reporting Standards as set out and agreed upon by all the accounting bodies.
The rates of depreciation used are entirely down to the proprietors and/or directors of a business and are normally set by reference to the expected useful life of the asset or class of asset.
Once chosen by a business, the rates applying to particular classes of assets should remain cinsistent over the years. For limited companies, it is a requirement to state the business' fixed asset depreciation policies in the notes to the accounts. If a policy is changed at any time, this also has to be noted in the statutory accounts together with the reasons behind the decision.
"Depreciation" is NOT a taxation requirement. In fact, the Revenue (in most cases) will ignore the depreciation charge as shown in the accounts when computing the taxable profits of a business. The reason they disallow the depreciation charge is because they are required, by tax law, to substitute their "version" of Depreciation, called "Capital Allowances".
Capital Allowances perform the same function as depreciation but the rates are set out under the Taxes Acts. The main difference between Depreciation rates and Capital Allowance rates is that CAs are often "political" in nature, in the sense that rates go up and down at the whim of the Chancellor based on what type of Capital Assets he wants businesses to invest in. This means that applying Capital Allowances rates instead of Depreciation in a set of accounts would result in inconsistencies in the treatment of assets over time - as the Chancellor fiddled about with the CA rates.
Under accountancy rules, "consistency" is one of the key elements of the concepts used when preparing financial information.
It is required under Accounting Standards and Financial Reporting Standards as set out and agreed upon by all the accounting bodies.
The rates of depreciation used are entirely down to the proprietors and/or directors of a business and are normally set by reference to the expected useful life of the asset or class of asset.
Once chosen by a business, the rates applying to particular classes of assets should remain cinsistent over the years. For limited companies, it is a requirement to state the business' fixed asset depreciation policies in the notes to the accounts. If a policy is changed at any time, this also has to be noted in the statutory accounts together with the reasons behind the decision.
"Depreciation" is NOT a taxation requirement. In fact, the Revenue (in most cases) will ignore the depreciation charge as shown in the accounts when computing the taxable profits of a business. The reason they disallow the depreciation charge is because they are required, by tax law, to substitute their "version" of Depreciation, called "Capital Allowances".
Capital Allowances perform the same function as depreciation but the rates are set out under the Taxes Acts. The main difference between Depreciation rates and Capital Allowance rates is that CAs are often "political" in nature, in the sense that rates go up and down at the whim of the Chancellor based on what type of Capital Assets he wants businesses to invest in. This means that applying Capital Allowances rates instead of Depreciation in a set of accounts would result in inconsistencies in the treatment of assets over time - as the Chancellor fiddled about with the CA rates.
Under accountancy rules, "consistency" is one of the key elements of the concepts used when preparing financial information.
Edited by Eric Mc on Wednesday 16th May 08:40
Thanks for the reply Eric.
At what point would the owners Capital be reduced by the depreciation.
Here's what's confusing me.
A sole trader introduces an asset, say a Motor Car, as an asset of the business on start-up, at a Cost £20,000 - it is the only Equity.
Say a depreciation charge of £2000 is made for the year, and that all Cash has been withdrawn as Drawings - there are no outstanding Debtors or Creditors.
Say Net Profit was £50,000 (inc Depreciation).
At the end of the year, I think the Balance Sheet will be:
Fixed Assets:
Cost £20,000
Depr (£2,000)
Total Net Assets £18,000
Financed by:
Equity £20,000
Profit £50,000
Drawings (£52,000)
Total Equity £18,000
Presumeably, the opening Balance sheet Equity is restated to clear drawings down:
Equity £20,000
Retained Net Profits (£2,000)
At what point does the £2,000 retained "loss" (being just the depreciation charge), be offset against Equity - or isn't it.
Any good books on the subject - is Frank Woods still a good bet?
Simon
At what point would the owners Capital be reduced by the depreciation.
Here's what's confusing me.
A sole trader introduces an asset, say a Motor Car, as an asset of the business on start-up, at a Cost £20,000 - it is the only Equity.
Say a depreciation charge of £2000 is made for the year, and that all Cash has been withdrawn as Drawings - there are no outstanding Debtors or Creditors.
Say Net Profit was £50,000 (inc Depreciation).
At the end of the year, I think the Balance Sheet will be:
Fixed Assets:
Cost £20,000
Depr (£2,000)
Total Net Assets £18,000
Financed by:
Equity £20,000
Profit £50,000
Drawings (£52,000)
Total Equity £18,000
Presumeably, the opening Balance sheet Equity is restated to clear drawings down:
Equity £20,000
Retained Net Profits (£2,000)
At what point does the £2,000 retained "loss" (being just the depreciation charge), be offset against Equity - or isn't it.
Any good books on the subject - is Frank Woods still a good bet?
Simon
Gassing Station | Business | Top of Page | What's New | My Stuff