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Why use reducing basis depreciation?

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Hello,

I have noticed that my company accounts is based on reducing basis depreciation. I am struggling to understand why this would be the case. When questioned my accountant I was told “I use the reducing balance basis because that is the method used by HMRC when first year allowances are not claimed”. Is this true?

With reducing basis depreciation I have assets which are still being depreciated but will soon be sold and thus I will have to take a hit on the income statement. I also find it difficult to forecast future years easily. 

Is there any good reason to be using reducing basis over straight line? 

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By johngroganjga
11th Mar 2019 12:55

I think you might have misunderstood what your accountant has said. The bit in particular about HMRC using the reducing balance basis makes no sense whatever.

The reducing balance basis is a perfectly respectable and widely used method for calculating depreciation, as is the straight line basis. If you wish to discuss the relative merits of them, and which one would be better for your company, I suggest you speak to your accountant, but listen more carefully to what he or she says this time.

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Replying to johngroganjga:
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By Accountant A
11th Mar 2019 13:02

johngroganjga wrote:

I think you might have misunderstood what your accountant has said.

In 2014 he was posting claiming to have clients and in 2013 said he was applying for "CIMA MiP".

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Replying to Accountant A:
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By Shamir
11th Mar 2019 13:51

Yes you are correct but decided not to presue it.

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Replying to johngroganjga:
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By Shamir
11th Mar 2019 13:48

Thank you for replying. I understand the HRMC bit makes no sense and thus why I am asking a question on this site. I have copied the comment from an email received from the accountant in the question and therefore it is not a question of me not listening carefully.

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By Matrix
11th Mar 2019 13:59

I have seen accounts using 18% reducing balance depreciation but to say that it has anything to do with HMRC is misleading.

Go back to your accountant and say that you were wondering how the accounting policy was decided since you would assume it would've related to the useful economic life of the asset. Also ask why AIA was not claimed on these assets, if that is what he/she is suggesting.

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By tom123
11th Mar 2019 14:28

If you are an external accountant, you can use reducing balance based on the cash values of purchases, disposals etc, without having to have a full register of the items.

Conversely, we were maintaining full asset registers with every last filing cabinet and chair on them and bfwd values of £10. - so, four years ago I moved to 25% straight line.

Next year all the crap will have gone from my fixed asset register.

We are sufficiently wise to cope with the differences between taxable and accounting profit.

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Replying to tom123:
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By WhichTyler
11th Mar 2019 14:37

tom123 wrote:

Next year all the crap will have gone from my fixed asset register.

It should still be on the register if you still have it, even if it has zero value. Don't forget to reduce cost & dep'n totals by the purchase price when you finally skip that filing cabinet...

(I know its pedantic, but it's not unknown for assets to 'walk' and sometimes the FAR is the only way of proving they should have been there in the forst place)

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Replying to WhichTyler:
Hallerud at Easter
By DJKL
11th Mar 2019 14:53

I write mine down to £1 and then carry them at this figure so as not to lose them, though plant going out to properties does tend to go walkies so a review each year re what is where can be helpful.

It is not that bad as all listed on excel, so sort by NBV column values, type in a zero depreciation for the year re first £1 NBV item, copy paste to all the others, reorder excel by date order.

Or if organised and vast number of lines use IF cell>1,Then to calculate the depreciation, else 0.

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Replying to tom123:
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By WhichTyler
11th Mar 2019 14:37

tom123 wrote:

Next year all the crap will have gone from my fixed asset register.

It should still be on the register if you still have it, even if it has zero value. Don't forget to reduce cost & dep'n totals by the purchase price when you finally skip that filing cabinet...

(I know its pedantic, but it's not unknown for assets to 'walk' and sometimes the FAR is the only way of proving they should have been there in the forst place)

Thanks (0)
Replying to WhichTyler:
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By tom123
11th Mar 2019 15:23

To an extent I agree, they will still 'exist' in terms of cost and depn - just with a NBV of nil.

The thing is, if I exclude computers, vehicles, and a few key items of plant like forklifts, the rest of the descriptions will just say "chairs, desk fan, new carpet" with not much else to go on.

Of course we are all sitting on chairs, and there are fans, but this is 20 years of dross.

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Hallerud at Easter
By DJKL
11th Mar 2019 14:35

It may be a more accurate measure of the value of the use of the asset by the business and the pattern of it using /consuming the economic benefit of the asset.

If one considers most vehicles it certainly possibly better measures the reduction in value/benefit consumed than straight line; certainly most cars lose more value in the initial years of ownership when new/nearly new and as time progresses the reduction in value tends to diminish year on year. (Though we did at one time have a Porsche and another time a Mclaren which needed large residual values factored into their depreciation calculations to make them sensible)

With computers I am far more inclined to use short term straight line as I replace them pretty frequently (3-4 years) and they tend to have little, if any, residual value, though we do have a cupboard full of old computers and printers that can provide the odd spare part when needed (fans being a common salvaged part over the years, but back in the old days RAM was also sometimes reused as were floppy drives/DVD drives etc)

With tools and equipment some of ours continue in use forever, we have a cherry picker that was secondhand when purchased sometime before I arrived in the 1990s and is still in service, similar re car lift, compressor, cement mixer and other larger workshop tools, so with these RB seems very appropriate.

On the other hand some smaller/lighter tools pretty much get written of over a couple of years, sanders and drills having a track record (these days) of expiring as soon as out of guarantee, even decent brands like Makita are no longer built to last (or our then employees were somewhat on the abusive side with their equipment).

What you really ought to do is consider the types of assets and how they are consumed by the business, this ought to then lead the policies/rates you use, imho, if material ,one size does not fit all

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Psycho
By Wilson Philips
11th Mar 2019 15:35

"I was told “I use the reducing balance basis because that is the method used by HMRC when first year allowances are not claimed”. Is this true?"

If that's what your accountant has told you, I don't see any reason to doubt him. It might not be a very sensible approach, but if that is the approach that he's taken then it must be true.

Whilst depreciation is intended to recognise the net cost of the asset over its useful economic life, I have seen on more than one occasion the accountant using the above method as it aligns with the rate of capital allowances and therefore avoids any of those nasty deferred tax computations!

Whether or not 18% RB is appropriate for the asset in question, that doesn't affect the veracity of your accountant's statement.

Out of interest, what depreciation policy does he adopt where Annual Investment Allowance is claimed - 100% in year 1?!!!!

Thanks (1)
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By andy.partridge
11th Mar 2019 15:55

You've lost me.

'I have assets which are still being depreciated' - so after all this time they have some value to you

'but will soon be sold' - so they have some value to someone else, too.

'I will have to take a hit on the income statement' - you would have preferred to take the hit in an earlier year, when they had more value? Why?

So far you are making a pretty good case for the reducing basis.

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RLI
By lionofludesch
11th Mar 2019 15:59

I don't have any strong feelings either way, myself, though I tend to use reducing balance.

If Shamir is taking "a hit on the income statement" maybe he needs to increase the rate of depreciation.

Nevertheless, over the life of the asset, the effect on P+L is the same. It's the difference between cost and sale price. If you're not taking a hit in the year of sale, you're taking a hit in some other year.

For me - not a big deal.

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By Andy Reeves
14th Mar 2019 10:32

Reducing balance basis makes it less likely that accounting staff will depreciate more than cost, and there will always be a carrying value for each asset, no matter how small.

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