Periodically, companies must provide accurate details indicating the financial health -- or otherwise -- of the organisation. These accounts consist of a balance sheet and supporting documents. Accumulated depreciation is a measure of the falling value of fixed assets. For companies that have made significant investment in equipment, machinery and other not-for-sale assets, accumulated depreciation can represent a considerable portion of their financial report.
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A balance sheet is a statement of a company’s finances, summing up assets, liabilities and equity at the end of an accounting period. A balance sheet is usually drawn up towards the end of a financial year. It is required by company investors and will also form part of a company’s tax return. As the name indicates, a balance sheet must balance. A company’s assets are equal to its liabilities plus its equity.
Accumulated depreciation is the total amount of loss of value of fixed assets up to the accounting period. Fixed assets are assets that are necessary but are not for sale. For example, a firm’s IT equipment might have cost £20,000, have an expected lifespan of five years and negligible final value. At the end of year two, the accumulated depreciation is £8,000, representing £4,000 per year. At the end of year three, it is £12,000, and so on.
According to Staffordshire University Business School, a balance sheet needs to show accumulated depreciation figures. Further advice is given by HM Revenue & Customs (HMRC). They say you need to take account of depreciation to arrive at the correct balance. The UK’s official legislation makes specific reference to accumulated depreciation in some contexts, such as The Registered Social Landlords Accounting Requirements (Scotland) Order 2007.
Variable depreciation rate
The government’s Business Link explains that while asset depreciation should feature on a balance sheet, there is another way of calculating it. Instead of a fixed annual rate of depreciation, you can vary the rate over the lifespan of the assets. Depreciation costs need to be realistic and a fixed annual rate of depreciation may not give an accurate financial picture. In reality, fixed assets -- such as buildings, equipment, machinery and land -- may each have their own varying depreciation rates.
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- Investopedia: Balance sheet
- Staffordshire University Business School: Week four - depreciation
- HM Revenue & Customs: BIM45715 - Specific deductions - interest: Overdrawn capital account - adjustments for depreciation and losses
- The Registered Social Landlords Accounting Requirements (Scotland) Order 2007
- Business Link: Balance sheets: the basics