# Depreciation NIGHTMARE!



## charlie-irl (14 Mar 2011)

Hi everyone, can someone please explain to me in simple terms what the hell depreciation is? Why do we need to depreciate stuff? I am trying to do a business plan and I am really lost when I get to the depreciation stage. For example, say I start a coffee shopp and I buy a fridge, dishwasher and an oven. Do I depreciate them? why does depreciation impact on my profits? HELP!!!

Thanks in advance, charlie


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## Brendan Burgess (14 Mar 2011)

Hi Charlie 

Very difficult to explain depreciation, but let me try.

Let's say your coffee machine is used so often that it only lasts one year and it's worth nothing after that year. You will agree that you should regard the coffee machine as a cost to the business and deduct the cost from profits at the end of the year. (For simplicity assume you bought it on the 1 January) 

Now let's say it lasts two years and then is worth nothing. Say it cost €12,000. Over two years, you should write off the machine, at €6,000 per year. 

Now let's say it lasts 4 years, then you should write it off at €3,000 per year.

*Example*
Let's say that your coffee machine is your only asset and that  you do everything else for cash. Let's say you make a profit before depreciation of €5,000.

At the start of the year, your balance sheet would be as follows: 

Asset:            €12,000
Share capital: €12,000

At the end of the year, your balance sheet will be 

Coffee machine  €12,000
Cash               €5,000
Total assets: €17,000

Financed by: 
Share Capital €12,000
Retained profit €5,000
Total            €17,000

Forget about accountancy for a moment, you know that the coffee machine is only worth €9,000 after a year.

So the accounts will be as follows: 

Profit before depreciation: €5,000
Less depreciation: €3,000
Net Profit :  €2,000 

Coffee machine at cost:  €12,000 
Less depreciation:        (€3,000)
Net value:                     €9,000
Cash                            €5,000
Total net assets            €14,000

Share Capital               €12,000
Retained Profit              € 2,000 
Total                           €14,000


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## charlie-irl (14 Mar 2011)

Thanks Brendan that seems a bit more manageable! Also can you give me a rough idea of what items I can depreciate for a coffee shop?

Much appreciated, Charlie


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## jpd (14 Mar 2011)

Fixtures & fittings can normally be depreciated. Anything that you buy that is going to last more than one year and which is not purchased for re-sale - so machines, fridges, tables, chairs etc.

You would need to make a list of each item and decide on it's likely life span eg fridge - 4 years, table -3 years, counter - 10 years, etc

The cost would then be spread out over the life of the items.


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## 44brendan (14 Mar 2011)

You can depreciate items by any ratio you like. However the Revenue have strict guidelines for what they will allow you to offset against your profits. These are fairly easy to access and understand. I suggest you contact the Revenue directly and they will send you out a helpful pack stating all the requirements for setting up a business. decide also as to whether you are going to trade as a sole trader or as a company. Ideally source an accountant as professional help will save you money and ensure that you are fully aware of all the regulations required in running a business.


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## Brendan Burgess (14 Mar 2011)

It's important to distinguish between depreciation which is an accounting concept and writing down allowances which is a revenue concept. 

For example, from an accounting point of view, you might choose to depreciate a computer over three years, but I think that the Revenue only allows you to write it off at 15% per year, reducing balance. 

When doing your tax return, you add back the depreciation when calculating the taxable profits but do a separate calculation for writing down allowances.

Brendan

From IT 48

*What is Capital Expenditure?*
Expenditure is regarded as “capital” if it has been spent on
acquiring or altering assets, which are of lasting use in the
business, for example, the purchase or alteration of business
premises, or the cost of plant, machinery or vehicles. You
cannot deduct the cost of this type of expenditure in arriving at
your taxable profit.

You can, however, claim Capital Allowances on capital
expenditure incurred on items such as office equipment,
business plant and machinery, vehicles and certain buildings (for
example, industrial buildings). Capital Allowances take account
of the wear and tear on these items and are deducted from your
profit figure before you are taxed on it.

*How are Capital Allowances calculated?*
Wear and Tear Capital Allowances on Plant and Machinery
(including motor vehicles) is calculated on a straight-line basis at
a percentage of the net cost. The net cost is the cost less any
grants and any VAT, which can be reclaimed.

Depending on when you purchased the item of plant or
machinery,* the rate of depreciation may vary as follows:*

Expenditure incurred on or after 4 December 2002 Wear
and Tear is calculated at 12.5% of the net cost,
Expenditure incurred between 1 January 2001 and
3 December 2002 Wear and Tear is calculated at 20% of
the net cost,
For plant and machinery purchased prior to and including
31 December 2000 Wear and Tear is calculated on the
basis of 15% for the first six years and 10% for the
seventh year.

*Example of Capital Allowances*
Net cost of plant and machinery purchased on 1 January 2006 is
€30,000 (including €26,000 for a motor vehicle).
Wear and Tear computation
Cost €27,000
Wear and Tear
2006 to 2013 (12.5% each year) = €3,375
The full €27,000 is allowed against your profits over eight years.
For private motor vehicles, Wear and Tear is calculated at a rate
of 12.5% per annum of the net cost. The net cost, however,
is restricted to £24,000 for all cars. The Capital Allowances
as calculated will be apportioned to exclude any private use.
The restriction by reference to cost of £24,000 does not apply
to a car in use as a taxi or in a car hire business. The annual rates
of Wear and Tear on such cars is 40% on a reducing balance
basis.

Further information on calculating Capital Allowances can be
obtained in Revenue’s “Guide to Completing Tax Returns”
which is available on Revenue’s website www.revenue.ie,
from Revenue’s Forms and Leaflets Service by phoning
LoCall 1890 306 706, or from your local Revenue office.


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## yewlands (15 Mar 2011)

Simple terms - didn't see that here - cutting and pasting a Revenue document and an over elaborate method of describing depreciation is hardly "simple terms"


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## JoeRoberts (19 Mar 2011)

Also remember that as you are doing a business plan you will have both a cashflow projection plan and a Profit & Loss plan.
Depreciation does not appear in the cashflow plan, the amount paid for the asset does.


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