Depreciation, Instant Asset Write Off and Business Valuations

The 2020 Federal Budget brought an important change for business owners. The change stated that small and medium businesses ‘can claim an immediate deduction for the business portion of the cost of assets in the first year the asset is used, installed or ready to use’. During the difficult times related to COVID-19, the threshold for the instant asset write off was raised to $150,000.  However the Federal Budget announcement (pending legislation) goes even further, allowing businesses with aggregated turnover under 5 billion to claim an immediate deduction for the full cost of any eligible assets acquired/installed before 30 June 2022, thus encouraging increased business investment. 

While not all businesses are currently in a position to further invest in equipment or other assets, we anticipate substantial increased investment for many of the clients we prepare valuations for. However in considering such investment, it is important that we understand the basics of a Business Valuation. 

Most businesses are valued on a multiple of their future maintainable earnings (otherwise known as ’expected annual profit’). Therefore, the impact of large purchases on the ongoing profit of the business needs to be considered, particularly in relation to recent Budget announcements. 

Instant Asset Write Off

On face value, ‘instant’ (or immediate) asset write-off is a one-off, non-recurring cost which would be either excluded, or adjusted for, in a business valuation. It is important to consider the annual ‘charge’ for the equipment. To do this a business needs to address questions such as:

  • How long will the asset last?
  • Will the asset provide excess capacity that is not utilised?
  • What might you pay for the asset if you leased it from an arms-length provider (where the lessor and lessee do not directly influence each other)? 

Depreciation

Similar to the instant asset write off, generous tax provisions enable many small businesses to depreciate assets (claim them over time) at an accelerated rate. An example of this is the depreciation of a computer. Tax legislation, prior to the instant asset write-off concessions mentioned above, allows for a computer to be written-off over three years. However, some businesses find a computer is still useful to them after this time. 

Depreciation is often an amount greater than the decline in value of the asset. In these circumstances the depreciation can be adjusted in the valuation. Adding back some of the depreciation would in turn increase ongoing profitability in these circumstances. 

Profit on disposal or sale of assets

Given that the instant asset write-off records assets as having a ‘nil’ value for tax purposes, we are now expecting to see an increase in the profit on sale of assets in the future. This will occur when an asset is sold above a zero price. In a business valuation, this is added back entirely as it is both ‘one off’ in nature and not core to business operations. 

Net Asset Valuation 

If there is no profit line in the business, it will sometimes need to be valued based on its net assets (assets minus liabilities). This valuation method considers the value of the assets at the date of valuation, e.g. if you have a piece of machinery that is three years old what is its estimated worth? It is important for this purpose, and record keeping more generally, for the assets to be added to your depreciation schedule/asset register and fully depreciated. 

If you have questions on how your business decisions may impact the value of your business, please call your Accru Adviser to explore this. 

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