Depreciation in Accounting Explained for Dummies

What is depreciation?

In accounting[1], depreciation is a method used to allocate (spread) the cost of a tangible or physical asset over its useful life, also referred to as its life expectancy.

Express differently, depreciation indicates how much of an asset’s value has been depleted over a certain period of time.

Each year the asset is in use, its value is decreased by a certain amount, recorded as depreciation in the accounting system. Depreciation enables a business to allocate the cost of an asset over a number of years, instead of realising the cost in one financial year.

Depreciation is an expense, although not a direct or explicit expense because no money is being paid out when the depreciation is recorded. It is called an imputed expense, a cost not incurred directly.

Examples of physical assets that are depreciated are, among others, office furniture, equipment, machinery, computer systems, and vehicles.

Depreciation also refers to the decrease in the value of the currency of a country in relation to currencies of other countries.

Methods of depreciation allowed in South Africa

In South Africa, the South African Revenue Service (SARS) allows ‘depreciation allowances’, also referred to as ‘wear-and-tear allowances’, for certain ‘qualifying assets.’

SARS describes a qualifying asset as ’machinery, plant, implements, utensils and articles qualifying for the allowance.’

SARS issued a document, “Binding General Ruling (Income Tax) 7 (Issue 4)”, with the subject, “Wear-and-tear or depreciation allowance” on February 9, 2025.

This is a useful document, explaining the rules and regulations regarding the application of depreciation for South African businesses.

An annexure – “schedule of write-off periods acceptable to SARS”, is available on pages 13 – 20 of the document. The annexure lists more than 50 qualifying assets with their ‘proposed write-off periods’ (in years).

The write-off periods refer to the useful life of the assets. An asset’s useful life (life expectancy) is the number of years that the asset is expected to be in use. The life expectancy can be more or less than the asset’s physical life.

The write-off period of a qualifying asset not included in the annexure must be determined by its expected useful life.  

SARS mentions the following factors to be considered in determining an asset’s expected useful life:

• How long the asset is expected to last.
• How the taxpayer expects to use the asset.
• Whether the asset is likely to become obsolete.
• Whether the duration of a particular project affects the useful life of the asset.

Methods allowed by SARS

According to SARS, taxpayers are allowed to choose between the following two methods of depreciation:

• The straight-line method

This is the simplest method of depreciation and the most common method used to record depreciation in the accounting system of a business.

The method involves the allocation of an even depreciation rate every year over the life expectancy of the particular asset. When the useful life of the asset is 5 years, the depreciation rate will be 20% (100%/5) per year.

Put differently, the straight-line method implies that depreciation will be claimed in equal installments over the lifetime of the asset.

The formula for the straight-line depreciation method is the cost price of the asset x depreciation rate.

• Example of the straight-line depreciation method

Business ABC purchased a mobile crane on 1 March 2025, the first day of the 2025 tax year (1 March 2025 – 28 February 2025) for R800 000. According to the annexure of SARS, the write-off period for mobile cranes is 4 years. Thus, the depreciation rate for the crane is 25% (100%/4). The depreciation each year will be R800 000 x 0.25 = R200 000.

The carrying value (original cost of the asset less accumulated depreciation) of the mobile crane will decrease each year by R200 000, as indicated in the table below:

The mobile crane’s carrying or book value will be R0 at the end of the fourth year. This value is also referred to as the salvage or scrap value.

However, an asset can never have a book value of zero. Therefore, by convention, the asset’s book value will be reduced to R1. Consequently, the depreciation in the 2025 tax year will be R199 999 and the accumulated depreciation R799 999.

The mobile crane will not be depreciated after the fourth year.

• The diminishing-value method

SARS describes this method as a method in which the depreciation ‘allowance for a year of assessment is calculated on the remaining value (also known as the income tax value), that is, the cost of the qualifying asset less an allowance for the previous years of assessment.’

It is also called the diminishing-balance method and is calculated using the following formula:

Depreciation allowance for the year = Book value x Depreciation rate.

As long as the cost price of the asset remains the same, the depreciation for each year decreases.

• Example of the diminishing-value method

Let us take the same information about the mobile crane in the example of the straight-line depreciation method.

The calculations will now look as follows:

The calculations for both methods for the 2025 tax year are the same but differs considerably thereafter.

According to the diminishing-balance method, the carrying value of the mobile crane will be R45 050 after 10 years, at the end of the 2031 tax year.

SARS regulations with regard to depreciation allowances

Some of the SARS regulations concerning depreciation allowances are:

• The value of a qualifying asset is the acquisition cost of the asset, which includes the following costs:
• The original purchase price. Regarding VAT included in the purchase price, the input tax to which the vendor is or was entitled is excluded. Contrarily, the input tax is included in the purchase price if the vendor was not allowed to deduct the input tax or if the taxpayer was not a registered vendor.
• Delivery or shipping charges related to the delivery of the asset.
• Installation or erection costs directly related to the asset.

However, finance and interest charges are not part of the cost of a qualifying asset.

• Moving costs

SARS allows that the value of a qualifying asset ‘be increased by the amount of any expenditure incurred by the taxpayer in moving the asset from one location to another.’

The rule is that the moving costs must ‘be written off over the remaining estimated useful life of the asset.’

For instance, if the asset’s write-off period is 6 years and moving costs are incurred in year 3, those costs will be allowed to be deducted in years 3 to 6.

• ‘Small’ items

SARS defines a ‘small’ item in the context of ‘wear-and-tear allowances’ as ‘one which normally functions in its own right, does not form part of a set and is acquired at a cost of less than R7 000 per item.’ (Accentuations are by the article writer.)

Any qualifying asset of R7 000 or less acquired on or after 1 March 2009 can be considered a ‘small’ item.

Regarding the situation where a ‘small’ item forms part of a set and is valued at less than R7 000, the following example is explanatory: The value of a dining room set which comprises eight chairs and a table is R55 000. The value of each chair is R5 000. Although valued at less than R7 000 per chair, the chairs of the set cannot be divided into eight individual independent items costing less than the specified amount of R7 000.

The total cost (R55 000) of the set, including the eight chairs, must be written off over its proposed write-off period, which is 6 years according to the annexure of SARS.

Depreciation calculated for a part of a financial year

It often happens that an asset is acquired or sold by a business during a financial year and must therefore only be depreciated for a part of the financial year.

For instance, a vehicle was bought by a business on 1 October of a specific year. The business’s financial year stretches from 1 March of a calendar year to 28 February of the following calendar year. Thus, the vehicle was bought at the beginning of the eight-month of the financial year and must be depreciated for only 5 months.

The calculation for the 5 months will be done as follows:

• First calculate the full depreciation for the financial year, using the straight-line method or the diminishing-balance method.
• Multiply the full depreciation by 5/12.

For example: The full depreciation for the financing for the vehicle is R50 000, which is multiplied by 5/12, providing an amount of R20 833, which is debited to the depreciation expense account.

Recording of depreciation

Depreciation is recorded in the general journal of a business’s accounting system. The accounts involved are ‘Depreciation Expense’, which is an income statement account, and ‘Accumulated Depreciation’, a balance sheet account.

For example: Company OSW possesses a truck that was acquired at a cost price of R500 000. Depreciation is calculated according to the straight-line method and the write-off period for the truck is 4 years, implying a depreciation rate of 25% (100%/4). Thus, the annual depreciation for the truck will amount to R125 000 (R500 000 x 0.25).

The corresponding journal entry will be recorded as follows:

Debit Depreciation Expense with R125 000

Credit Accumulated Depreciation with R125 000

The Depreciation Expense account is closed off at the end of each financial year, while the balance in the Accumulated Depreciation account is carried forward to the next financial year.

What is accumulated depreciation?

Accumulated depreciation is a balance sheet account, indicating the total of all the depreciation recorded on an asset up to a specific date.

Accumulated depreciation is called a contra asset account, meaning the account will be presented in the asset section of the balance sheet, but it will show a credit balance. (Normally, assets that are indicated in the asset section of the balance sheet have debit balances.) Sometimes, accumulated depreciation is referred to as a negative asset.

Accumulated depreciation is shown on the balance sheet just below the related asset. For example, company XYZ has a vehicle of R400 000 (cost price), and the accumulated depreciation related to the vehicle amounts to R200 000. The presentation on the balance sheet will look as follows:

Assets

The difference between the debit balance in the Vehicle asset account and the credit balance in the Accumulated Depreciation – Vehicle account of R200 000 is called the vehicle’s book value or carrying value.

[1] See the article, ‘Accounting Explained for Dummies,’ for a general overview of accounting.