Accounting depreciation

What it means

Accounting depreciation reflects the actual wear of a fixed asset over its useful life according to the company's accounting policy. It spreads the asset's cost as an expense over the years in which it provides benefit, giving a true and fair view of asset values and profit.

The company itself sets the depreciation period, method and residual value based on how it expects to use the asset, and records them in its depreciation plan. Straight-line depreciation is most common, but units-of-production or accelerated methods are also possible.

Accounting depreciation may differ from tax depreciation, which the Income Tax Act sets through fixed depreciation groups and periods. The difference is adjusted in the tax return, so it is tax depreciation, not accounting depreciation, that enters the tax base.

How it works in practice

Many small companies set accounting depreciation equal to tax depreciation for simplicity. This is acceptable if it reflects actual wear. For assets that wear out faster or more slowly than the law assumes, however, it is correct to use the company's own depreciation period.

For larger assets such as buildings or production lines, component depreciation can be used, depreciating significant parts with different useful lives separately. A building's roof or the technology inside it, for example, may have a shorter life than the load-bearing structure.

The difference between accounting and tax depreciation is dealt with in the tax return as an add-back or deductible item. For companies that account for deferred tax, the difference creates a temporary difference from which a deferred tax asset or liability is calculated.

What to watch out for

The depreciation plan must be applied consistently. The period or method may be changed if circumstances change, such as the way the asset is used, but not to improve the result on purpose. Changes must be justified and documented.

If an asset's value falls by more than depreciation reflects, for example through damage or obsolescence, an impairment allowance or an extraordinary write-down should be considered. Regular depreciation alone may not capture a sudden drop in an asset's value.