Depreciation plan

What it means

A depreciation plan is the internal rule in which an entity sets out how it will depreciate fixed assets: the method, the useful life and the month the charge starts. Drawing one up is required by the Accounting Act, not by tax law.

It is not the same thing as tax depreciation. Tax depreciation follows the depreciation groups in the Income Tax Act, while the accounting charge is meant to show how the asset really wears out in this particular business.

The plan can be changed, but only going forward and for a reason, such as a change in how or how intensively the asset is used. Past years’ depreciation is not rewritten; the change is spread over the remaining life and its reason is given in the notes to the financial statements.

How it works in practice

The plan normally sits inside the internal accounting policies and answers practical questions: how low-value assets are handled, what happens to the charge after a technical improvement, and when a useful life is revisited.

Accounting depreciation is booked as the year runs, usually every month. The difference against tax depreciation is settled in the return as an add-back or a deductible item and, in companies that report it, feeds deferred tax.

For a new company we build the plan around the asset groups the client actually has: IT equipment, vehicles, machinery, fit-out of rented premises. Each group gets a useful life and the reason for it, so that an auditor or the tax office can check it.

What to watch out for

The usual mistake is to copy the tax groups and call that a depreciation plan. A machine worn out by four years of double shifts then sits on the balance sheet for twelve, the company reports profit it never earned, and the whole residual value drops into costs in the year it is scrapped.

Accounting depreciation cannot be skipped just because it would spoil the result. Tax law allows a suspension of depreciation, accounting does not: an asset in use wears out, and a skipped charge is an error that an auditor or a bank will find when reviewing the statements.