How do I account for depreciation on PCP car deal

How do I account for depreciation on PCP car deal

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I am one of the two equal partners in a partnership. We are not a limited company. We have recently bought 2 new cars using the PCP finance model. We will never own the cars as at the end of the term we either give the cars back to the finance company or we pay a balloon payment and can then buy them at a pre-determined market value price.

My question is, do we need to account for the depreciation of these vehicles in our profit and loss account? At the moment our accountants are adding £1800 a month depreciation into our overheads, which is a substantial amount for us. I have queried it and they've told me that the only way to avoid adding depreciation into the P&L is to either a) take the cars out of the business and pay for them personally or b) if the vehicles are leased or rented. I thought PCP was a lease so am confused as to what is right.

Can anyone help with this?

Replies (32)

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By johngroganjga
23rd Jul 2015 11:05

Why is this a problem for you?

Depreciation is just a book entry. it has no effect on your cash balance or on the tax you pay.

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By johngroganjga
23rd Jul 2015 11:13

And why do your reported profits matter?  Who apart from you, your partner and your accountant see your accounts?

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By mfrgolfgti
23rd Jul 2015 11:24

Noone

Well the bank sees them, but apart from that, no-one else. But it's a mental thing, seeing a lower figure each month is a bit demotivating.

Aside from that, how about my original question: if we have bought the cars using PCP finance, do we still need to account for depreciation in our P&L account?

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Replying to Paul Crowley:
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By Mr_awol
23rd Jul 2015 11:49

It's all the same in the end

mfrgolfgti wrote:

Well the bank sees them, but apart from that, no-one else. But it's a mental thing, seeing a lower figure each month is a bit demotivating.

Aside from that, how about my original question: if we have bought the cars using PCP finance, do we still need to account for depreciation in our P&L account?

 

See above re bank.

As for your own motivation - add them back in (in your own mind, in pen, etc).  Regarding depreciation - if they've been capitalised then yes they will need depreciating.  When you get shot of them if you've not depreciated enough to account for the reduction in value then youll get an extra lump sum taken off your P+L to reflect the difference (and if you've depreciated them too much then some will be reversed).

Onewa or another, over the time that you have them, the correct amount that they have cost you will show in your accounts.  It's simply a matter of timing

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Replying to Asiko:
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By mfrgolfgti
23rd Jul 2015 11:55

Got it!

OK, yes I get it now. Thank you for explaining, you've been very helpful.

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By cheekychappy
23rd Jul 2015 11:26

You are being silly.

 

The depreciation reflects the use of the vehicle in your business.

 

If I were you I would spend more time trying to increase the profits than worrying about accounting entries.

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Replying to lionofludesch:
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By mfrgolfgti
23rd Jul 2015 11:40

Thank you John, I have private messaged you

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By Mr_awol
23rd Jul 2015 11:35

Do you intend on keeping the cars?  Or know 100% that you wont?  Or are you going to wait and see?

If you know you're handing them back then there is an argument for including the balloon payment as a residual value and depreciating the balance over the term of the finance.

I largely agree with John - I wouldn't suggest bothering about it in most cases.  If you are reliant on bank/supplier finance though, and if the depreciation is a much higher figure under the current method, then I can see why you'd want it done 'properly'

 

(by 'properly' I mean with reference to the residual value.  As accountants we should always consider this when calculating depreciation but there are so many unknowns that normally we tend to just use 25% reducing balance with no RV for vehicles in the vast majority of cases as it's pretty standard practice.  I'm not suggesting your current accountants have done anything 'wrong').

 

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Replying to SXGuy:
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By mfrgolfgti
23rd Jul 2015 11:51

We won't keep the cars

Thank you Mr_awol

We intend giving the cars back at the end of the 4-year period. And yes, our bank does see our figures and we rely on them for an overdraft facility so I don't want to show high depreciation and therefore lower profits unless it is really necessary. So I am thinking from your comments that there might be an argument for deducting the pre-determined residual value of the vehicles and then depreciating the remainder? IE car costs £35,000, residual value is £13,000 so we actually depreciate £22,000 over 4 years? Sorry to be so basic.

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By gwilkinson
23rd Jul 2015 11:36

It depends...

A PCP can be classified as both a Finance Lease or an Operating Lease.

Leases are classified based on the nature of the contract.

Finance Leases typically have the characteristics of paying a deposit, paying a monthly amount and subject to meeting the conditions the ownership transfers to the lessee for a nominal purchase price.

In some finance leases, you may have the option to buy at a substantially higher price (market price), such that the lessee may not exercise the right to purchase at the end of the contract and can therefore be treated as an operating lease. As in the case of PCP.  But if you intend to purchase the car at the end, you could argue this is a Finance Lease and recognise the asset (as your accountants have done).

Operating Leases typically have a monthly charge and no right to purchase. And is charged to your P&L with no asset recognised.

If under an operating lease your present value of the minimum lease payments comes to more than 90% of the market value you can presume that the risks and rewards have substantially passed to you and therefore you class the lease as a Finance Lease and recognise the asset (SSAP 21).

From the point of view of your situation, presently you have a depreciation charge.  I assume therefore your accountants have also claimed Writing Down Allowance, giving you a deduction for tax at 18% of the value of the car per year (but you may have an enhanced first year allowance depending on efficiency of the car).

If you were to treat the cars as an operating lease, you would have the cost of the lease on your P&L, and your tax relief would come from the deduction of the expense from your profits, at your marginal rate of tax.

Hope this helps.

 

 

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Replying to Partyondudes:
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By mfrgolfgti
23rd Jul 2015 11:45

Very useful answer

Thank you gwilkinson, this is an extremely useful answer, I think I understand the situation much better now.

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By johngroganjga
23rd Jul 2015 11:39

I agree. I would leave the accounting entries to your accountant and get on with running your business.

And of course, if your accountant removed depreciation from your profit and loss account he would have to replace it with the finance repayments you are making. Would that be more or less demotivating for you than the depreciation? 

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Replying to lionofludesch:
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By mfrgolfgti
23rd Jul 2015 11:43

less

It would be less demotivating because the finance repayments are less than the depreciation being charged.

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Richard Hattersley
By Richard Hattersley
23rd Jul 2015 12:12

.

It’s the moderator here. While you may have received guidance on this matter from our members, I would recommend that you contact your accountant.

 

All the best, 

Richard

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Replying to Tax Dragon:
By cheekychappy
23rd Jul 2015 12:19

Policy

Richard Hattersley wrote:

It’s the moderator here. While you may have received guidance on this matter from our members, I would recommend that you contact your accountant.

 

All the best, 

Richard

 

Have Sift had a change in policy regarding these types of posts?

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Replying to paul.benny:
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By andy.partridge
23rd Jul 2015 12:25

I doubt it

cheekychappy wrote:

Richard Hattersley wrote:

It’s the moderator here. While you may have received guidance on this matter from our members, I would recommend that you contact your accountant.

 

All the best, 

Richard

 

Have Sift had a change in policy regarding these types of posts?


I doubt it. If they had they would change the registration process. It might take Sift being sued by a taxpayer for poor advice for that to happen.
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Replying to Tax Dragon:
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By mfrgolfgti
23rd Jul 2015 12:21

guidance

Yes I will do that, thanks Richard.

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By alanhone
23rd Jul 2015 12:43

Question?

If you do not "own" the cars, at least while the PCP lease is running, you do not have an asset to depreciate - the finance company does, and they build that cost into the lease payments. When the lease is up you will have already paid, in "rentals", the loss of value of the asset.

If you THEN choose to buy the car, it will come onto the books as an asset at the cost agreed with the vendor (the Finance Co) at that time.  Until then the monthly charges (only) are an expense to be borne.  I don't see where depreciation of a non-asset comes into it.  Your accountants should explain themselves to you.  I doubt if the bank have a clue - they only (usually) look at the balance in the account and the "expected" cashflow - but I may have just become too cynical.

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By Mr_awol
23rd Jul 2015 13:07

Complicated

It's complicated because we cant see the agreement, so are trying to cover several possibilities.  With the PCP contract in hand it would probably be quite simple.

 

Some of them allow for purchase if you want, some of them specifically wont allow it.  Some of them are effectively HP with a guaranteed p/x built in.

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By nick farrow
23rd Jul 2015 13:07

operating lease

surely if this is effectively an operating lease there cannot be depreciation in which case it would be easier to have a contract hire agreement

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By gwilkinson
23rd Jul 2015 13:28

'Ownership'

@alanhone

You need to distinguish between an asset from the point of view of accounting (a resource controlled by an entity as a result of a past event and which future economic benefits are expected to flow to the entity), and legal ownership.

You do not need to legally own an asset for it to be recorded as an asset in your financial statements.

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By alanhone
23rd Jul 2015 16:39

Ownership & Depreciation

@ gwilkinson

This may depend upon whether these are accounts for the tax return ( depreciation irrelevant, as previously noted), or, as I was supposing, management accounts for the business to see how they're faring and show the bank that they are a good risk   I am finding it hard to see how a car, used under PCP finance scheme, is an asset for depreciation in either case.

The final balloon payment to take ownership (if allowed under the contract) is for the depreciated value of the car, which the monthly payments partly cover and are (usually) tax allowable.  If you claim depreciation as well it is surely (in this instance) being effectively claimed twice.

This is different to Hire Purchase, where you buy the asset and rent the money.  The residual risk is then yours, not the finance company's.

I think the OP's term "Bought the cars" is therefore misleading.  "Chose the cars" may be more accurate.

The devil may be in the contract detail and the OP's accountants should be able to explain their rationale - but it still looks odd to me!

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By mfrgolfgti
23rd Jul 2015 16:46

Technically

Yes alanhone you're right, it is misleading of me to say we bought the cars, because they are not ours, they are financed by the PCP. We are allowed to take ownership if we wish at the end of the 4-year term, or we can give the car back to the finance company in exchange for another new vehicle.

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By nick farrow
23rd Jul 2015 16:49

operating lease

I rent my offices I'm not going to depreciate them as well

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Replying to Tax Dragon:
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By mfrgolfgti
24th Jul 2015 11:57

good one

good point :-)

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By King_Maker
23rd Jul 2015 17:17

PCP = Personal Contract Purchase ( for those unfamiliar with the acronym).

Are the cars even partnership assets? In the various accountancy partnerships which I have been involved with, cars were always kept off the Balance Sheet.

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By miketombs
24th Jul 2015 11:47

Surely there's only one answer

Ask your accountant to explain why they are depreciating the cars. Keep asking them until you understand it. If they can't/won't explain to your satisfaction (which doesn't mean you like the explanation, but does mean that you understand it) find another accountant.

Am I the only one who found the 'don't worry about understanding the numbers, just get on with running the business' type of responses a bit arrogant?

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Replying to Paul Crowley:
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By mfrgolfgti
24th Jul 2015 11:56

I will do that

Hi miketombs

Thanks for your suggestion, I will do that. I'm meeting them in a couple of weeks actually to discuss end of year figures and have said I'd like to discuss this with them so they can explain it.

Yes I also found those comments a bit arrogant. I replied to the individual by private message to thank him for the advice but did he realise it came across as a bit rude and he blocked me! Not sure why he bothered replying to be honest, it wasn't very helpful :-)

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Replying to Paul Crowley:
By cheekychappy
24th Jul 2015 12:04

Mike

miketombs wrote:

Ask your accountant to explain why they are depreciating the cars. Keep asking them until you understand it. If they can't/won't explain to your satisfaction (which doesn't mean you like the explanation, but does mean that you understand it) find another accountant.

Am I the only one who found the 'don't worry about understanding the numbers, just get on with running the business' type of responses a bit arrogant?

 

Reading would help you greatly.

 

Nobody said don't worry about understanding the numbers. What was said was that worrying about accounting entries is silly and to spend their resources trying to increase the overall profitability. Where would you stop at worrying about accounting entries effecting profits? Accruals, prepayments? 

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By Mr_awol
24th Jul 2015 13:54

Arrogance

Noun.  Offensive display of superiority or self-importance; overbearing pride.

 

Got to love the irony................

 

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