Accounting Depreciation vs Tax Depreciation

Learn about depreciation from both accounting and tax perspectives

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What is Accounting Depreciation vs Tax Depreciation?

Before we discuss accounting depreciation vs tax depreciation, let us first talk about depreciation itself. Essentially, depreciation is a method of allocating the cost of a tangible asset over several periods of time due to decreases in the fair value of the asset. Note that amortization is a concept similar to depreciation, but it is applied primarily to intangible assets.

Accounting Depreciation vs Tax Depreciation

Also, the concept of depreciation is applicable to both accounting and tax practices. In accounting, depreciation is referred to as the cost of a tangible asset allocated over the periods of its useful life, which is treated as a company’s expense. Depreciation expenses are subtracted from the company’s revenue as a part of the net income calculations.

On the other hand, for tax purposes, depreciation is considered as a tax deduction for the recovery of the costs of assets employed in the company’s operations. Thus, depreciation essentially reduces the taxable income of a taxpayer. The tax deductions are generally available to both individuals and organizations. The tax rules regarding depreciation deductions may significantly vary among tax jurisdictions. For example, in some countries, the tax regulations allow full deductions of the asset’s cost, while other jurisdictions allow only partial deductions.

What is Accounting Depreciation?

Accounting depreciation (also known as a book depreciation) is the cost of a tangible asset allocated by a company over the useful life of the asset. The recognition of accounting depreciation is driven by accounting standards and principles such as US GAAP or IFRS. Remember that depreciation is a non-cash item. In other words, depreciation expense does not represent an actual cash flow for a business.

Despite its non-cash nature, depreciation expense still appears on the company’s financial statements. A company records its depreciation expenses on the income statement. Thus, this non-cash item ultimately reduces the net income reported by a company.

In addition, most accounting standards require companies to disclose their accumulated depreciation on the balance sheet. The accumulated depreciation reveals the impact of the depreciation on the value of the company’s fixed assets recorded on the balance sheet.

Accounting depreciation can be calculated in numerous ways. The two most common ways to determine the depreciation are straight-line and accelerated methods.

The straight-line depreciation is the easiest and most frequently used depreciation method. It distributes depreciation expenses equally over all periods of the asset’s useful life.

Conversely, accelerated depreciation methods allow deducting greater depreciation expenses in the earlier periods of the asset’s useful life and smaller depreciation expenses in the subsequent periods. One of the examples of the accelerated depreciation method is the double declining depreciation method.

What is Tax Depreciation?

Tax depreciation is the depreciation expense listed by a taxpayer on a tax return for a tax period. Tax depreciation is a type of tax deduction that tax rules in a given jurisdiction allow a business or an individual to claim for the loss in the value of tangible assets. By deducting depreciation, tax authorities allow individuals and businesses to reduce the taxable income.

A taxpayer cannot claim depreciation for all assets. Only some assets that meet the specific requirements in the given tax jurisdiction may be eligible for the depreciation claim. Although the requirements generally vary among the tax jurisdictions, the most common criteria for the depreciable assets are:

  • The asset is the property owned by a taxpayer.
  • A taxpayer uses the asset in the income-generating activities.
  • The asset possesses a determinable useful life.
  • The asset’s useful life is more than one year.

In some jurisdictions, the tax authorities publish guides with detailed specifications of assets’ classes. The guides may specify the lives for each class of assets and their respective methods of depreciation calculations. For example, the Canada Revenue Agency (CRA) publishes the guide for capital cost allowance (CCA), which includes the classes of different assets with their respective depreciation rates. In the United States, the Internal Revenue Service (IRS) publishes a similar guide on property depreciation.

Additional Resources

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