When you start running a business, you will inevitably come across terms like ‘Fixed Assets’ and ‘Asset Depreciation’ without really understanding them. Therefore, before discussing the important role and calculation of asset depreciation in the world of accounting, you must first understand the understanding. The term depreciation for many is a form of business and business losses.
In accounting, the term depreciation has a definition as a systematic reduction in the carrying cost of a fixed asset until the value of the asset becomes zero or has no economic value. Depreciation allows a portion of the cost of a fixed asset to income derived from a fixed asset. As it turns out if you do not understand and take into account fixed assets and depreciation of assets appropriately, the performance of your business will be affected.
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What Is Fixed Asset?
Fixed assets are the tangible assets that a company owns and uses for more than a year to obtain profits. They are not for sale. When you own a fixed asset, any cost during its usage does not represent a cash transaction, but it plays an important role in the balance sheet. Therefore, a fixed asset does not have any immediate effect on your profit.
Read more about fixed assets here.
What is Depreciation?
Depreciation is an accounting method that allocates the cost of fixed assets during their usage period and describes the declining value of the asset from the time since you purchased it.
For example, you have a car for your business operations. The car is a 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 the company’s balance sheet, according to the estimation of fixed asset usability used during the utilization period. For example, there is an expense for maintenance from when it was purchased until it lost its utilization. It means that this expense has deduced the net profit. Due to its effect on profit calculation, you must record the asset depreciation.
What Kind of Trouble If You Do Not Calculate Depreciation?
After knowing the understanding of depreciation in general in the world of accounting. So now you need to know the important role of calculating asset depreciation to support the business. There are several things that will happen if you do not take into account the depreciation of the asset. Of course, this impact is not a good thing for your company. Here’s the impact that may occur when you don’t take into account asset depreciation.
Distorted Business Value
If you do not depreciate your capital asset value correctly, you won’t see its real value. Eventually, it will cause financial position inaccuracy in the company. The value of an asset will be over 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. In addition, you will confuse the prospective investors due to profit uncertainty, and it will impede you from increasing your capital.
Without depreciation calculation, the return tax may exceed the original amount you need to pay because your profit is overstated. Other than that, you will have errors in capital expenses deduction for tax returns. 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, suppose there’s a huge amount of differences in tax return calculation. In that case, the tax department may conduct a formal investigation for your business and re-audit the amount of your tax return. Again, your company’s credibility is at stake.
Incorrect Asset Utilization Period
If the depreciation is not calculated or, even, not considered, you won’t 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 obvious that you have to put a precise calculation in the accounting report. However, the 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 locate, track, maintain, and predict the utilization period of the fixed asset. Therefore, you can keep a distance away from those troubles.