When you start building your business, you may find the terms ‘fixed asset’ and ‘asset depreciation’ without really grasp what it means, especially if you’re a layman in accounting.
Apparently, if you do not try to comprehend and actually practice the theory in your business, something dreadful will occur in your business operation.
What Is Fixed Asset?
Fixed asset is tangible asset that a company owns and used more than a year to obtain profits. Fixed asset means that you do not plan to cash the thing you own for business purposes.
When you own a fixed asset, any cost during its usage does not represent a cash transaction but in the balance sheet, it plays an important role.
Therefore, a fixed asset does not owe any immediate effect on your profit.
Read more about fixed asset here.
What is Depreciation?
Depreciation is an accounting method that allocates the cost of fixed asset during its time of use and describes the declining value of the asset from the time since you purchased it.
For example, you have a car for your business operation. The car is the fixed asset. You can use this asset for years. However, due to several factors such as physical damage, declining economic value, and time, this car loses its productivity from time to time.
This is what asset depreciation is.
Depreciation is an expense in company’s profit and loss in a year according to the estimation of fixed asset usability that has been used during the utilization period. For example, there is an expense for maintenance from the first time it was purchased until it lost its utilization.
It means that this expense has deduced the net profit.
Due to its effect in profit calculation, you must record the asset depreciation.
What Kind of Trouble If You Do Not Calculate Depreciation?
There is some chaos that will occur in your business if you do not calculate the depreciation value. For sure, it will affect your business future heavily.
Distorted Business Value
If you do not depreciate your capital asset value correctly, you won’t be at its real value, which results in inaccuracy of the financial position of the company.
The value of asset will be over recorded in the books of accounts. If the asset value is higher than the actual value, then the books of accounts show a higher profit.
At the same time, negligence of depreciation may sometimes, hide the losses incurred in the business.
This is not good for your business because the not calculated profit and loss will affect your business’s health. You will confuse the prospective investors due to profit uncertainty and it will impede you to increase your capital.
Without depreciation calculation, the return tax may exceed more than the original amount you need to pay because your profit is overstated.
Other than that, you will have error in capital expenses deduction for tax return. It will not be a trouble if it’s just a basic mathematical error. The tax department can fix the trouble without having to contact you.
However, if there’s a huge amount of differences in tax return calculation, the tax department may conduct a formal investigation for your business and re-audit the amount of your tax return. Your company’s credibility is at stake.
Incorrect Asset Utilization Period
If the depreciation is not calculated or, even, not considered, you won’t be able to know when to replace the assets and maximize its utilization period.
You can be late in replacing the assets which have lost their productivity. It will decide your business operation. It even worsens if you do not prepare any budget for it.
To avoid those problems, it is very clear that you have to put a precise calculation in accounting report. However, manual calculation will be inefficient and the risk of inputting the wrong number is there.
You might want to consider applying ERP that includes accounting software for a precise depreciation calculation. It will help you in locating, tracking, maintaining, and predicting the utilization period of the fixed asset. Therefore, you can keep a distance away from those troubles.