You may generally select between utilising the prime cost or diminishing value technique to compute depreciation. A depreciating asset is expected to be worth more at the start of its useful life than at the end under the declining value model.
The simple equal amounts of depreciation of an item over a predetermined number of years are known as Prime Cost or Straight Line depreciation. So, if an asset costs $2000.00 and has a ten-year effective life, the equal annual depreciation instalments over ten years would be $200.00 p.a. Diminishing Value, on the other hand, permits you to accelerate depreciation, allowing you to claim more now but less afterward.
Based on the above example, the diminishing value method permits you to claim $300.00 in the first year, but Prime Cost only allows $200.00. However, Prime Cost continues to produce a claim of $200.00 each year as time passes, whereas Diminishing Value begins to decline.
Why diminishing value is better
The essential argument, though, is “time worth of money.” Today’s $1.00 is worth more than tomorrow’s $1.00. Inflation is the explanation behind this. We all know that when things become more expensive, our dollar’s buying power decreases. So having additional cash now is preferable to waiting until next year to file a larger depreciation claim. As a result, you should always take advantage of valid tax deductions as soon as they become available.
How to use the prime cost approach to calculate depreciation
The prime cost depreciation technique, often known as the simple depreciation method, determines commercial depreciation schedules of assets.
The following is the prime cost formula:
Cost of asset x (days held 365) x (effective life of asset 100 percent)
If an asset costs $100,000 and has a ten-year useful life, you may deduct 10% of the cost for each of the ten years:
$10,000 is $100,000 multiplied by (365 365) times 10%.
The depreciation computations will go on until the asset’s ultimate value is zero.
How to use the diminishing value approach to calculate depreciation
The method of diminishing value depreciation provides for a bigger depreciation deduction in the initial few years of property ownership.
The prime cost depreciation technique, as you can see, provides a set rate of depreciation. On the other hand, the dimishing value technique offers a larger upfront deduction in the first four years of the asset.
The formula for declining value is as follows:
(200 percent of the asset’s effective life) x (base value x (days held 365)
If an asset costs $100,000 and has a 10-year effective life, the first-year deduction is:
$100,000 divided by (365 365) divided by (200 percent 10) = $100,000 divided by 20% = $20,000
The base value will decrease in the coming years depending on the current year and the next year. In this case, the asset’s base value for the second year will be $80,000, equal to $100,000 minus $20,000 in depreciation for the first year.
Which depreciation method should I use for my property?
Residential quantity surveyors understand that the prime cost depreciation approach is more straightforward and offers uniform depreciation. However, the diminishing value method gives higher upfront depreciation in the early years before gradually decreasing over time.
There are a few things to think about before you choose your preferred method.
How long do you intend on keeping the property?
If you don’t plan on selling your property in the next forty years, the depreciation outcome will be the same. Unforeseen events arise, and you may be forced to sell even though you had no intention of doing so.
Do you want to use the property as your primary home or as a rental?
If you reside in your home and then decide to rent it out, you may lose the ability to claim tax deductions despite having an apartment depreciation schedule. Other variables, such as government incentives and grants, may give more substantial advantages, so depreciation may not be a consideration.
Inflation
Because the cost of living and general prices rise yearly due to inflation, $1 today is no longer worth $1 next year. As a result, many investors choose to employ the declining value depreciation technique to claim the additional deductions to invest and use the money as quickly as feasible.
What is the most accurate technique of computing depreciation?
You may calculate depreciation for your assets using a variety of ways. The Diminishing value and prime cost methods are widely used. Contact us at 1300 313 524 if you’d like to learn more about these strategies.