What is a low-value asset (LVA)?

A low-value asset is an asset whose ac­qui­si­tion costs fall within defined limits. It varies from country to country, but some have tax laws that state that the full amount of the ac­qui­si­tion costs of LVAs can either be noted as an expense in the year that the ac­qui­si­tion was made, or cap­i­tal­ized and de­pre­ci­at­ed over the planned useful life. Examples include personal computers or small items of office furniture – this election can be made on a lease-by-lease basis.

Asset de­pre­ci­a­tion is an ac­count­ing method of al­lo­cat­ing the cost of a tangible asset over its useful life. It could also be seen as “expensing” a fixed asset i.e. a per­cent­age of the cost of the fixed asset that becomes an expense, and then has a lower value on the balance sheet. This doesn’t reflect actual money being passed over, but refers to the “cost to the company”.

Busi­ness­es choose to de­pre­ci­ate long-term assets for both tax and ac­count­ing purposes. Although the value of an asset is written off over time, it isn’t con­sid­ered a non-cash trans­ac­tion. De­pre­ci­a­tion makes sense to busi­ness­es, since it helps to spread out the cost of equipment over time. There are two methods of asset de­pre­ci­a­tion:

One method is straight line dep­re­ca­tion, for example, a company buys a piece of machinery for $10,000. This amount can be written off in the same year the machinery was bought, or the amount could be spread out over how many years the machinery will be in use – this is de­pre­ci­a­tion. If the machine is expected to be in use for 10 years, then the company needs to expense $1,000 each year against net income for the decade of use. By lasting a decade, it means there’s an annual de­pre­ci­a­tion rate of 10%. This is then trans­ferred to the profit and loss account from the balance sheet each year for 10 years. This means that after the first year, the balance sheet value becomes $9,000 and the $1,000 has been charged as de­pre­ci­a­tion on the profit and loss account.

The formula for straight line de­pre­ci­a­tion is:

Annual de­pre­ci­a­tion expense = (asset cost – residual value)/useful life of the asset

Another method is reducing balance de­pre­ci­a­tion, which is used when the fixed assets gradually loses value so it’s difficult to predict how long it can be used for. If a van costs $10,000, 20% ($2,000) could be de­pre­ci­at­ed in the first year, resulting in a balance of $8,000. Then in the second year, 20% is taken from the reduced balance of $8,000 (rather than the original value of the van), which would be $1,600 rather than $2,000 since the van decreases in value each year and is no longer of the same quality of the year before.

Anyone reading your financial state­ments can get a good idea of how well your assets are doing by looking at your ac­cu­mu­lat­ed de­pre­ci­a­tion. If they see that your assets are close to being fully de­pre­ci­at­ed, they know you will soon need to spend a sig­nif­i­cant amount of money on replacing or repairing these assets. Asset de­pre­ci­a­tion can be ac­cel­er­at­ed if you believe that the asset won’t be used evenly over its lifetime, because it might be used more often in its earlier years, for example. Depending on the type of ac­count­ing system used (i.e. com­put­er­ized or manual), the amount may be cal­cu­lat­ed au­to­mat­i­cal­ly or you will have to make the ad­just­ments by hand.

Assets are treated in a different way to expenses in your company accounts. Assets are “cap­i­tal­ized” and included in the company balance sheet as assets, rather than written off to profit and loss account as expenses. Valid expenses are tax de­ductible, but de­pre­ci­a­tion is treated dif­fer­ent­ly: Companies can’t obtain tax relief on de­pre­ci­a­tion charges, but can claim a “capital allowance” on the cost of the equipment. Capital al­lowances are set in the budget each year, but vary depending on the type of equipment.

If de­pre­ci­a­tion is not used in ac­count­ing, all assets have to be charged to expense once they are bought. This will result in a sig­nif­i­cant loss in the trans­ac­tion period that follows. So, not using the de­pre­ci­a­tion expense in your accounts could result in in­ac­cu­rate amounts on income state­ments and balance sheets, making it harder to organize your finances. Is it worth the hassle of adding de­pre­ci­a­tion values to your ac­count­ing process each year? Yes, recording de­pre­ci­a­tion can lead to tax savings and better al­lo­ca­tion of funds for future asset purchases.