Are you finding it hard to keep track of fixed assets depreciation manually? This could be costing your company time and money that could be spent better elsewhere.

In order to maintain accurate financial records and make informed decisions, accountants in charge of fixed assets must understand net book value, the types of depreciation and how to choose the best method, and the impact of depreciation on taxes. A key component in managing fixed assets is finding the right tools for the job.

Keep reading to learn the essentials of fixed assets depreciation for your growing business. 

Table of Contents

• What are fixed assets?
• What is depreciation?
• Types of depreciation
• What is the difference between depreciation and amortization?
• What is net book value and why is it important?
• How is depreciation calculated for tax purposes?
• How QuickBooks can help
• FAQ

What are fixed assets?

Fixed assets are items used to earn business income that have an enduring life, such as equipment, land, buildings, and vehicles. Sometimes also called capital assets, fixed assets can be tangible or intangible, depreciable or non-depreciable.

Here are some examples of each type of fixed asset:

Tangible (physical)

• Machinery
• Vehicles
• Buildings
• Equipment

Intangible (non-physical)

• Patents
• Goodwill
• Trademarks
• Copyrights

Depreciable

These assets wear out and lose value over time:

• Machinery
• Vehicles
• Computers
• Equipment

Non-depreciable

This type of asset does not typically lose value over time:

• Land

How are fixed assets classified?

Fixed assets are classified as long-term assets on the balance sheet. This is because they are expected to last longer than one year and provide future benefits for the business.

• Financial statements also tend to group fixed assets as property (land), plant (buildings), or equipment. Generally, a note to the financial statements will show balances for each of the property, plant, and equipment (PP&E) categories, and the balance sheet will show a total for fixed assets.

What is depreciation?

Depreciation is the process of expensing a portion of a fixed asset over its useful life.

Fixed assets cannot be expensed at the time they are purchased. According to generally accepted accounting principles (GAAP), expenses must match the revenue generated by them. This means that if a piece of manufacturing equipment is expected to generate revenue over five years, the purchase of the equipment must also be expensed over five years.

However, there are a few methods of calculating depreciation that are accepted under GAAP: straight-line, declining balance, double declining balance, and units of production. 

Types of depreciation

Depreciation isn't as straightforward as determining the useful life of an asset and expensing a portion of the asset for each year of life. There are other things to consider, such as the salvage value of the asset (how much the asset might be worth at the end of its life), how quickly an asset loses its value, how the economy affects the asset's life, and what happens when asset usage fluctuates.

Choosing the right depreciation method depends on the specific circumstances surrounding the business and the assets the business owns.

Straight-line

Straight-line depreciation is calculated by taking the cost of the asset, subtracting its estimated salvage value, then dividing by its useful life. It's best for assets that wear out consistently over time, like buildings or office furniture.

Salvage value is also referred to as residual value or scrap value. It's the amount an asset is worth at the end of its life — the price it could be reasonably sold for. There is no set calculation for salvage value, as the value is based largely on estimates, industry standards, and the current economy.

Straight-line depreciation method:

Annual depreciation = (Cost of asset - Salvage value)/ Useful life

Example:

A hotel purchases a new building for $700,000 with an estimated salvage value of $100,000 and a useful life of 20 years.

Annual depreciation = ($700,000 - $100,000)/20 years = $30,000

The hotel will record depreciation expenses of $30,000 each year for 20 years.

Declining balance

Some assets, like cars and machinery, depreciate more rapidly during the early years. Because of this, salvage value is not a consideration in the declining balance or double declining balance methods of calculating depreciation.

For fixed assets like these, the declining balance depreciation method is more appropriate because it takes this fact into consideration. Declining balance depreciation is calculated by multiplying the book value at the beginning of the year by the depreciation rate.

Formula:

Annual depreciation = Book value of asset at beginning of the year x Depreciation rate

Example:

A manufacturing company purchases a machine for $100,000. The machine has a useful life of 10 years and a depreciation rate of 20%. It is common practice to assign depreciation rates based on asset classes in the Income Tax Act (ITA). This doesn't always equal the depreciation rate calculated based on the useful life of an asset.

In this case, the useful life of 10 years would result in a 10% depreciation rate ($100,000/10 years = 10% per year).

Because manufacturing equipment has a 30% depreciation rate per the ITA, this company has opted to go with an average of the rate calculated using useful life and the rate suggested in the ITA (10% + 30% = 40%/2 = 20%).

In year one, declining balance depreciation is calculated as $100,000 x 20% = $20,000.

In year two, the current book value must be considered, so depreciation is calculated as the original purchase price of $100,000 minus the $20,000 depreciation expensed in year one ($100,000 - $20,000) x 20% = $16,000.

Double declining balance

Double declining balance is a variation of the declining balance method for calculating depreciation, and it is used where the declining balance method doesn't reflect how quickly an asset is depreciating. This is most often seen in the tech sector, where equipment can become obsolete quickly.

This method accelerates depreciation compared to the standard declining balance method. It achieves this by applying double the straight-line depreciation rate to the book value of an asset. This resulting increased depreciation expense reflects the more significant decrease in value during the early years of the asset.

The primary reason for using this method is to match the higher expense with the earlier, more productive years of the asset's life. This can be helpful when the asset's economic benefits decrease significantly over time, as seen in the tech industry.

To calculate double declining balance depreciation, follow these steps:

1. Determine the straight-line depreciation rate, assuming a salvage value of zero: Straight-line rate = 100%/Useful life
2. Double the straight-line rate: Double declining balance rate = 2 x Straight-line rate
3. Calculate depreciation expense: Depreciation expense = Book value x Double declining balance rate

When recording depreciation expense, it's important to remember that the net book value of an asset cannot be a negative number. Since the formula calculates a percentage of the book value, it's highly unlikely this will occur, but it's something to watch out for nonetheless.

Example:

An IT firm buys new servers for $50,000 with an estimated life of 5 years.

1. Calculate Straight-line rate (assuming zero salvage value): $50,000 / 5 years = $10,000/year (or 20%).
2. Double the rate: 20% x 2 = 40%.
3. Year 1 Depreciation: $50,000 (Book Value) x 40% = $20,000.
4. Year 2 Depreciation: ($50,000 - $20,000) x 40% = $12,000.

Units of production

The units of production method of depreciation is best used for equipment where its usage can vary significantly from one period to the next. This method seeks to match expenses directly to how much the asset is used. Unlike methods that depreciate a fixed amount per year, this approach matches depreciation expense to actual output or usage.

Depending on the type of asset, the units of production (also referred to as units of measurement) can include:

• Kilometres (kms) driven (vehicles)
• Hours operated (machinery)
• Units produced (manufacturing equipment)

Formula:

Depreciation = (Cost of asset - Salvage value) / Total expected units

Example:

A transportation company buys a truck for $80,000 with a $5,000 salvage value and 200,000 km lifespan.

• Depreciation per km: ($80,000−$5,000)/200,000 kms=$0.375/km.
• If driven 25,000 km in the first year:
• Year 1 Depreciation: $0.375/km×25,000 kms=$9,375.

When considering which depreciation method to use, consider:

• The nature of the asset
• The use of the asset
• Industry best practices
• Compliance restrictions such as accounting standards and tax regulations

What is the difference between depreciation and amortization?

Depreciation and amortization are sometimes used interchangeably, but they are two different things.

Depreciation applies to tangible assets, like equipment and machinery, and amortization applies to intangible assets, like patents, trademarks, and copyrights.

Where depreciation accounts for the deterioration or obsolescence of physical assets, amortization accounts for the gradual expiration of intangible rights. Unlike depreciation, the only recognized way to calculate amortization is the straight-line method.

For example, a copyright is protected for 70 years after an author dies. If a mid-sized publishing company pays $50,000 for the copyright of a book with 50 years remaining on the copyright, it would have an amortization expense of $1,000 per year.

Amortization Formula:

Annual amortization expense = Cost / Useful life

$50,000/50 years = $1,000 per year

• It's important to understand the difference between depreciation and amortization because they must be shown separately on the balance sheet. 

What is net book value and why is it important?

Net book value (NBV), also called book value, is the value a fixed asset is shown at on the balance sheet. It's the assets cost minus the depreciation that has been expensed each year (the accumulated depreciation).

Formula:

NBV = Cost of asset - Accumulated depreciation

If NBV isn't considered when calculating depreciation, the amounts calculated will be incorrect. The NBV of an asset provides a realistic estimate of an asset's current value. Tracking NBV can help businesses make decisions about and prepare for repairs, replacements, or upgrades.

With some types of assets, the NBV isn't an accurate reflection of an asset's fair market value (the value it would be purchased or sold for). This is often seen in real estate where the prices are a reflection of what's happening in the economy at the time.

In situations where an asset is sold and its NBV is lower or higher than its fair market value, a gain or loss on the disposal would be recorded.

For example, a building was sold for $800,000 but its NBV was only $400,000. A gain on the disposal of the asset would be recorded for $400,000.

How is depreciation calculated for tax purposes?

Depreciation is calculated differently for tax purposes than it is for accounting purposes. The Canada Revenue Agency (CRA) administers the Canadian Income Tax Act and uses a system of depreciation called capital cost allowance (CCA).

Like depreciation, CCA allows for a portion of the cost of an asset to be deducted each year.

The way CCA is calculated is based on the CCA class of the asset. These classes are set by the CRA and they specify the rate to be used to calculate annual CCA.

Some common classes and rates are:

• Class 1 (4%) - buildings
• Class 8 (20%) - furniture and equipment
• Class 10 (30%) - vehicles
• Class 43 (30%) - manufacturing and processing equipment
• Class 50 (55%) - computer hardware

For a complete list of CCA classes and rates, see the CRA website.

CCA is calculated like the declining balance method, with one exception: the half year rule. For tax purposes, during the year an asset is purchased, a business can only claim half the normal amount of CCA. This rule attempts to adjust for the fact that most assets are purchased part-way through a year.

Pro tip: QuickBooks Online Advanced integrates with your tax software, reducing manual entry errors so you can transfer financial data directly into your tax return.

How QuickBooks can help

Fixed assets depreciation management can become challenging if a business has multiple fixed assets with differing depreciation rates. QuickBooks Online Advanced is made especially for mid-market businesses with complex fixed assets depreciation.

Use QuickBooks Online Advanced to manage your assets efficiently while maintaining accurate financial records.

Record and track fixed assets

QuickBooks Online Advanced allows you to easily categorize assets by type and assign classes or locations for streamlined reporting. Record important information like purchase dates, serial numbers, and warranty details all in one place.

You also have the ability to tag assets with custom fields so you can create reports that track asset usage and depreciation, giving you a clear picture of the company's resources.

Automated fixed assets depreciation

As a business owner, you know that managing depreciation manually can be a significant drain on your time and resources and can lead to potential errors and inefficiencies.

QuickBooks Online Advanced now automatically creates schedules and records book depreciation, saving you significant time to focus on what matters most in your business.

Calculate net book value

Understanding NBV is key to making informed financial decisions. By tracking the original cost of assets and their accumulated depreciation, QuickBooks Online Advanced helps you calculate NBV.

Report generation allows you to view an asset's value at any time, helping you plan for replacements or maintenance. To keep your financial records accurate and current, you can easily update asset values when significant changes occur, like repairs or upgrades.

Communicate with your accountant

Growing businesses often rely on outside support from professional accountants. QuickBooks Online Advanced allows you to grant accountant access so they can view depreciation schedules, asset details, financial reports, and more.

By using QuickBooks custom roles and permissions, accountants and finance team members only have access to the information they need, minimizing security risks.

Ready to simplify fixed asset management? QuickBooks Online Advanced is the right tool for mid-size businesses. Learn more today. 

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