Tax depreciation versus accounting depreciation - useful information for entrepreneurs

If there are any inadequacies identified as a result of checks by state tax agencies, heavy penalties may be imposed, which may even decisively affect the smooth running of economic activity. Important accounting and tax issues include the phenomenon of depreciation, which can be used to spread the costs of acquiring fixed assets over a longer period.

Publication date: 7 February 2023

In the article below you will find out what tax and accounting depreciation are, what the main differences are between the application of these two elements, and discover which calculation methods are applicable in order to accurately determine the tax and accounting depreciation of assets.

Contents:

1. Tax depreciation and accounting depreciation

1.1. What is tax depreciation - definition

1.2. What is accounting depreciation

2. Tax depreciation versus book depreciation - Differences applicable in practice

2.1. Tax and accounting depreciation methods

2.2. Tax and accounting depreciation period

2.3. Amount of tax and accounting depreciation introduced into the ledger

3. Calculation methods applicable for tax and accounting depreciation

1. Tax depreciation and accounting depreciation

Acquiring or upgrading fixed assets is very often a necessity in many types of business, because it adds value to the company, increases production capacity and eliminates the danger of physical and moral wear and tear on equipment that is essential to their operations.

This approach must always be accompanied by the drawing up of accounting documents, which clearly show the level of expenditure and its destination, as well as tax documents, through which the Romanian state agencies can correctly establish the level of taxes and duties owed by the company.

The two categories of documents form an approach known as depreciation, which can be defined as a way of spreading costs over a longer period and as a correct way of deducting amounts used for investments in order to reduce the company's taxable income.

1.1. What is tax depreciation - definition

When a company invests in the purchase or production of fixed assets, it may be possible to deduct the money used for this purpose, thus obtaining an exemption from corporation tax. These assets are known as depreciable fixed assets. Not every type of investment falls into the category of depreciable fixed assets, as the Romanian state laws indicate precisely which categories of investment can be deducted in this way:

• Investments for the purchase or production of fixed assets (there is also the possibility that they are only rented, leased or even leased under management);
• Investments for fixed assets not yet completed, which have not been recorded as tangible fixed assets;
• Money used for further modernisation of fixed assets;
• Where the aim is to extract subsoil resources, expenditure on stripping may be regarded as depreciable for tax purposes;
• Development of land for various purposes;
• Money used for setting up vocational and technical educational processes.

Entrepreneurs should be aware that there are also some types of investment and expenditure which cannot be written off in this way. An example of this is investment in land acquisition, as this does not have a fixed duration of use. Other expenditure is the purchase of protocol houses, cruise ships, works of art and other fixed assets that do not degrade over time, such as lakes, ponds and ponds.

1.2. What is accounting depreciation

Ministry of Public Finance Order No 1802 / 2014 defines book depreciation as a method by which the depreciable value of a fixed asset can be divided over the estimated useful life of that asset. In practice, this type of depreciation makes it possible to record in the accounting records the normal reduction in the value of the fixed asset during its use. More specifically, it is considered that, as a result of its use, a fixed asset loses value and its fair value cannot be recorded at the time of purchase but must reflect reality.

In order to ensure correct depreciation, the order of the Ministry of Finance states that certain precautions must be taken:

• The determination of the depreciation period must take into account the physical and moral wear and tear of the fixed asset. It may be used effectively for a limited period of time, and at some point the necessary repairs will be worth more than the economic effect of using the asset (in which case it is no longer worthwhile using the asset, but replacing it with a new, more efficient one);
• Fixed assets are depreciable only if they meet certain conditions laid down in economic legislation;
• The calculation of depreciation starts at the beginning of the month following the acquisition of the asset;
• Book depreciation ceases when the economic life of the asset is over and its value has been fully recovered;
• For the correct application of the depreciation calculation, the entry value of the assets and the revalued value of the fixed asset shall be taken into account.

2. Tax depreciation versus book depreciation - Differences applicable in practice

Entrepreneurs, regardless of their experience and the level of the business they run, should have a minimum of accounting and tax knowledge in order to be able to make the right decisions for economic success. They need to know the differences between the two types of depreciation in order to avoid confusion in their application and to avoid irregularities that could be penalised by the Romanian tax institutions.

2.1. Tax and accounting depreciation methods

As regards the methods that can be used in tax and accounting depreciation, the economic regulations differentiate between methods that can be applied for tax depreciation and those for accounting depreciation. Thus, tax depreciation can be carried out either by applying the accelerated or the declining balance method. In the case of book depreciation, on the other hand, the recommended method is the straight-line method, which gives the best results and captures the aspect correctly.

2.2. Tax and accounting depreciation period

The depreciation period is different for book depreciation than for tax depreciation. For example, in the case of the first category, the economic life is taken into account, i.e. the period during which the asset, through its use, brings benefits. To determine this period correctly, there is no formal requirement, but previous experience is taken into account, which shows how long an asset can be used effectively, or technical expertise is carried out to show precisely and scientifically whether the asset can still be used or should be disposed of.

In the case of tax depreciation, the length of time is formally established by means of a document known as the "catalogue of classification and normal useful lives of fixed assets". This document was drawn up by the Romanian state institutions by drawing up a list of fixed assets to which a minimum and a maximum number of years of use was assigned. Entrepreneurs can choose from this range what tax depreciation period they use for the asset in question.

As regards the duration of tax depreciation, this must be entered in the tax depreciation register, on the basis of which corporation tax is calculated. The document must be drawn up accurately, as it is an external record and can be consulted by state institutions if there is any suspicion of fraudulent intent.

2.3. Amount of tax and accounting depreciation introduced into the ledger

In the preparation of the tax and accounting depreciation register it will be taken into account that in the case of accounting depreciation of fixed assets there is no minimum value, in this sense even investments of a few hundred lei can be entered, while when a tax depreciation register is made, there is a regulation that stipulates a minimum entry value of the asset is 2500 lei, according to Government Decision number 276 of 2013 (in the near future it is expected that this threshold will increase to 5000 lei to take into account the updating of the consumer price index). Therefore, if the investment required to purchase an asset does not reach the minimum threshold, it cannot be considered as depreciable.

3. Calculation methods applicable for tax and accounting depreciation

As regards the calculation methods that can be applied for tax and accounting depreciation, different types can be used, which have advantages and disadvantages and are chosen, in particular, according to the type of depreciable fixed asset. Often the calculations are quite complex and any mistakes can be costly, which is why it is advisable to take the utmost care or outsource the accounting service to firms specialising in accounting consultancy and other areas useful to entrepreneurs.

The three types of calculation that can be applied under the Tax Code are straight-line depreciation, which is obligatory for investment in construction, straight-line, declining balance or accelerated depreciation for technological equipment, and straight-line and declining balance depreciation for other categories of depreciable fixed assets.

Straight-line depreciation can be applied both as a tax method and as an accounting method. It is most commonly used in practice because it is easy to apply, the mathematical formula being simple. Specifically, the value of the asset is divided by its entire useful life, giving a number of equal amounts which are deducted annually until the investment is fully recovered. In this case, the value of the asset is that established at the time the asset enters the taxpayer's assets.

Accelerated depreciation differs from straight-line depreciation in that the resulting deductions are not equal amounts spread over the years of use of the asset. Instead, the deductions are higher in the early years, becoming lower towards the end of the asset's life. The method can be applied by stipulating, however, that the maximum percentage depreciable in the first year must not exceed 50% of the tax value. It is also laid down that what remains to be depreciated after the first year has elapsed is calculated by dividing the amount remaining to be depreciated by the number of years of use of the asset.

Depreciation is based on the idea that a fixed asset loses value every year it is used. The deduction, both accounting and tax, will be calculated taking into account the value of the input each year. In the first year depreciation is calculated on the basis of the acquisition value of the asset. In subsequent years the depreciation percentage is the same, but is applied only to the remaining undepreciated value. The cycle is repeated until the end of the economic life.

The normal useful life of the asset is taken into account in determining the correct depreciation rate. In this respect, the Tax Code provides for three circumstances:

• If the fixed asset has a normal useful life of between 2 and 5 years, the depreciation coefficient of 1.5 is used;
• If the fixed asset will be active for 6 to 10 years, a depreciation coefficient of 2 will be applied;
• When the asset has an economic useful life of more than 10 years, a calculation factor of 2.5 should be applied.

In conclusion, the existence of basic information on tax depreciation and accounting depreciation is a must for every entrepreneur, because the correct application of these two elements can bring significant advantages that can ensure economic success.

*This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.