Depreciation and capital allowances
Most contractors will purchase items for business purposes which will have a useful life for over a year, or even for several years. These items could be things like a computer, office furniture or telephone equipment. Such purchases could also potentially include goods and services associated with research and development, as the results could also eventually add ongoing value to the business. In accounting terms items which have a use or value to a business of over a year, and which cost over £1,000, are termed assets. Most assets will lose value over time and will eventually have to be replaced. In accounting terms this loss of value is demonstrated in a company’s accounts using a calculation called ‘depreciation’.
At its simplest depreciation is a calculation which shows the current value to the business of an asset within a specific accounting period. It is used to write off the cost of the asset across the period of its usefulness to the business. The most commonly used method of calculating depreciation is called ‘straight line’ depreciation. With this method the same amount is taken off the value of the asset for each year that it is deemed to have a useful life.
As a simple example, if a computer was bought for £3,000 and was depreciated over 3 years the calculation would be:
Asset value (purchase price) / period of useful life = depreciation per year
£3,000 / 3 years = £1,000 per year
The depreciation amount will be shown in the profit and loss accounts as a depreciation expense.
The value of the asset will be shown as the original purchase cost(s) less the depreciation amount, known as the ‘net book value’. This amount will not necessarily be the same as the current market value. This means that although in some cases the actual market value of an asset – say a computer – will fall very quickly, the accounts would show a steady decline in value with the depreciation spread across several years.
Assets are treated differently to expenses for tax purposes and are usually ‘capitalised’ i.e.: shown as being part of the company’s capital in the accounts. A company cannot claim any tax relief on the depreciation costs of an asset, unlike other valid expenses which are 100% tax deductible. What they can do instead is claim for a ‘capital allowance’ against the costs associated with the asset. Calculating how much capital allowance should be claimed can become complex. Capital allowance amounts vary depending on the type of asset involved, so it’s important to apply the right rate. The allowance rates themselves also change each year because they are set in the annual budget. Another complication is that the amount of depreciation shown in the company accounts will often be a different amount to the sum of capital allowances claimed. This means that the company profit shown in the accounts may legitimately be different to the amount taxable under corporation tax. Due to this complexity, in most cases it’s recommended you let a professionally qualified accountant do these calculations for you.
Claiming back VAT on capital assets under the Flat Rate Scheme
Those who are VAT registered and using the Flat Rate Scheme won’t usually be able to claim back the VAT on capital assets purchased as this is taken into account in the flat rate applicable to their business type. However, it may be possible to claim if the VAT-inclusive purchase price is £2,000 or more. In order to be eligible the purchase must comply with HMRC rules which include:
- It must be a single purchase of £2,000 or more from the same single supplier.
- It must be a purchase of capital goods, not services.
- You can’t claim on items you intend to resell, hire out or incorporate into other goods you intend to sell.
- You can’t claim on items you intend to use up within a year
If you are un-clear on the eligibility of an item you’ve purchased speak to your accountant for further advice.
Recording Fixed Assets
As a director of your company you have a responsibility to keep an accurate record of all your company’s assets. Keep your accountant updated too so they have an accurate schedule of your fixed assets.
At Intouch our clients simply need to keep us fully up to date with details of their capital asset purchases via the portal. They can then sit back and relax as their personal accountant will take care of the tax issues for them.
This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.