Depreciation on Computer Software: All You Need to Know
Computer software has become an integral part of every business operation. For accounting purposes, depreciation is applied to tangible assets such as machinery and equipment.
But what about computer software? Is it eligible for depreciation?
The answer is yes, but with certain conditions.
What is Depreciation?
Depreciation is the reduction in the value of a tangible asset over time due to wear and tear, obsolescence, or other factors. It allows businesses to recover the cost of an asset gradually over its useful life.
Types of Assets that Can Be Depreciated
Tangible assets such as buildings, machinery, vehicles, furniture, and equipment can be depreciated. However, intangible assets such as patents and copyrights cannot be depreciated.
Is Computer Software Eligible for Depreciation?
According to the IRS guidelines (Internal Revenue Service), computer software can be depreciated if it meets the following criteria:
- The software must be owned by the business entity.
- The software must have a determinable useful life.
- The software must be expected to last more than one year.
- The software must not be classified as supplies or repairs.
If the above conditions are met, then computer software is eligible for depreciation.
How to Calculate Depreciation on Computer Software?
Depreciation on computer software can be calculated using two methods – straight-line method and accelerated method.
Straight-line method: In this method, the cost of computer software is divided by its useful life. The resulting amount is deducted from taxable income each year until the asset has been fully depreciated.
Accelerated method: In this method, a higher amount of depreciation is applied in the early years of the asset’s useful life. This method is used when an asset becomes obsolete quickly.
Computer software can be depreciated if it meets the IRS guidelines for depreciation. It is important for businesses to keep accurate records of their software purchase and installation costs, as well as any upgrades or enhancements made to the software. By doing so, businesses can claim the maximum depreciation expense allowed by law and reduce their tax liability.