Common Mistakes SMEs Make With Depreciation and Amortization (And How to Avoid Them)

Amortization and depreciation don’t have to be complicated accounting terms. Consider them instruments that provide a narrative about the physical condition of your assets and the returns on your investments.

However, many SMEs make mistakes when putting these ideas into practice, frequently without even realising it. In this blog, we will explain what is wrong and offer helpful advice on how to fix it without needing an accounting degree.

What Is The Difference Between Depreciation And Amortization?

Amortization	Depreciation
Applies only to intangible assets	Applies only to tangible assets
Philosophically spreads an asset’s cost	Philosophically reduces an asset’s value
Generally, it is only done using the straight-line method	Has many methods a company may choose from.
Often results in the same amount recorded each year	May result in accelerated, inconsistent amounts recorded each year
Doesn’t incorporate salvage value when determining amortization base	May incorporate salvage value when determining depreciation base.
May not always use contra assets	Always uses contra assets

What Is The Depreciation And Amortization Formula?

Depreciation and amortization both spread the cost of an asset over its useful life.

• Depreciation applies to tangible assets (like equipment or vehicles).
• Amortization applies to intangible assets (like patents or software).

Depreciation Formula (Straight-Line Method): Depreciation= Cost of Asset−Salvage Value​/Useful Life

Amortization Formula: Amortization = Cost of Intangible Asset/Useful Life

Both methods help allocate asset costs evenly across accounting periods, giving a clearer picture of your business’s financial performance.

To know particularly on how to calculate depreciation for your SMEs and its various methods, read our guide – Depreciation Accounting: A Practical Year End Guide For UK SMEs to know your facts.

Which Mistakes Do SMEs Make When Calculating Depreciation And Amortization?

When it comes to tracking depreciation and amortization, many SMEs make straightforward but expensive mistakes. These errors have the potential to misrepresent the true worth of assets, distort financial statements, and impact tax deductions. The following are a few of the more typical ones:

Using the Wrong Useful Life: Inaccurate reporting of expenses may result from overestimating or underestimating the lifespan of an asset.

Ignoring Salvage Value: Depreciation costs are inflated when the residual value of an asset is not taken into consideration.

Misclassifying Assets: Inaccurate estimations and confusion result from combining tangible and intangible assets.

Not Updating Asset Values: When disposals, renovations, or revaluations are not taken into account, financial records are neglected.

Applying Inconsistent Methods: When depreciation techniques (such as declining balance versus straight-line) are switched without the necessary documentation, consistency is compromised.

How Do These Mistakes Affect Year End Accounts And Tax Returns?

Depreciation and amortization mistakes can affect more than simply bookkeeping; they can ruin your whole financial picture. Inaccurate asset valuation or expense can have several negative effects on your year-end accounts and tax returns.

Inaccurate Profit Figures: Depreciation can be overstated or understated. If the amount is inaccurate, it will affect net profit and make performance seem better or worse than it is.

Reduced Credibility: Reports that are inconsistent or incorrect generate concerns with regulators, banks, and accountants.

Poor Decision-Making: Wrong information can lead to making wrong decisions, which might impact cash flow issues, poor investment timing, or excessive spending.

Accurate, compliant, and tax-efficient financial statements that provide you with a real picture of business success are ensured by properly handling depreciation and amortization.

How To Calculate, Post, And Reconcile Depreciation & Amortization (Step-By-Step)

Accurately recording depreciation and amortization guarantees that your assets and expenses are valued properly in your financial statements. From calculation to reconciliation, here’s how to do it step-by-step.

Step 1: Identify the Asset and Useful Life

Start by determining:

• Asset type (e.g., equipment, vehicles, buildings, patents)
• Acquisition cost (purchase price plus any installation or setup fees)
• Estimated useful life (the period you expect to use the asset)
• Salvage value (expected residual value at the end of its useful life)

Use the same guidelines for amortization, but concentrate on intangible assets like software, licenses, and trademarks.

Step 2: Choose a Depreciation or Amortization Method

Choose the best approach depending on the asset’s characteristics and accounting standards (GAAP or IFRS). Common techniques consist of:

• Straight-Line Method: (Cost – Salvage Value) ÷ Useful Life
• Declining Balance Method: (Book Value × Depreciation Rate)
• Units of Production: (Cost – Salvage Value) × (Actual Usage ÷ Total Estimated Usage)

The straight-line method is most frequently used for amortization because intangible assets typically yield benefits evenly over time.

Step 3: Record (Post) the Depreciation or Amortization Expense

Create a journal entry in your general ledger each accounting period:

For Depreciation:

Dr. Depreciation Expense

       Cr. Accumulated Depreciation

For Amortization:

Dr. Amortization Expense

     Cr. Accumulated Amortization (or Intangible Asset)

While your balance sheet lowers the asset’s book value, this guarantees that your income statement shows the expense.

Step 4: Update the Fixed Asset Register

After posting, update your Fixed Asset Register (FAR) or subledger to:

• Reflect the new book value of each asset
• Include accumulated depreciation/amortization to date
• Note any changes in useful life, additions, or disposals

This maintains an accurate record for audit and reporting purposes.

Step 5: Reconcile with the General Ledger

At the time of month-end or year-end:

• Check the General Ledger (GL) control accounts against the Fixed Asset Register balance.
• Look into and fix any discrepancies (such as unrecorded asset increases or missed journal entries).
• Verify that the two systems’ total amortization and depreciation match.

Step 6: Review and Adjust (If Necessary)

Periodically reassess:

• Asset useful lives and residual values
• Impairments or disposals
• Compliance with accounting standards and internal policies

Any changes have to be recorded and shown in your GL and FAR.

Audit-Ready Checklist To Avoid SME Filing Errors

Keeping correct financial records is not just a good idea, but also necessary for regulatory compliance and audit preparation. It is easy for small and medium-sized businesses (SMEs) to make mistakes that could result in tax penalties, audit modifications, or compliance problems. Utilise this checklist to maintain error-free and audit-ready books throughout the year.

Verify All Source Documents: 

• Make sure all transactions are backed up by contracts, invoices, or receipts.
• Assign each deposit and payment to the appropriate document.
• Organise physical and digital copies according to category and date.

Reconcile Bank and Credit Accounts Monthly:

• Check bank statements against your cashbook and general ledger.
• Look into transactions that don’t match or have time discrepancies right away.
• As proof, keep signed or electronically approved reconciliation reports.

Review Depreciation & Amortization Entries: 

• Monthly, check the records of depreciation and amortization.
• Adjust the balances in the General Ledger (GL) and Fixed Asset Register (FAR).
• Check that rates, procedures, and useful lives comply with accounting rules.

Check Payroll and Tax Liabilities: 

• Verify that the payroll journals match the bank transfers and payroll registration.

• Make sure that corporate taxes, VAT, social security, and PAYE are filed and paid on schedule.
• Keep track of all necessary paperwork and confirmations for use in audits.

Ensure Compliance with Accounting Standards: 

• Use uniform guidelines for the recognition of revenue and the classification of expenses.
• Look for any significant errors or missing disclosures in the financial statements.
• Follow any changes to local GAAP or IFRS that may have an impact on SMEs.

Secure and Back up Financial Data: 

• Regularly back up accounting data to external disks or safe cloud storage.
• Review permissions every three months and limit system access according to user roles.
• Establish a version control procedure for audit reports and accounting files.

Conduct a Year-End Pre-Audit Review: 

• Compare trial balance totals to the corresponding schedules.
• Check accruals, provisions, and adjusting entries for accuracy.
• All working papers, ledgers, and reconciliations should be clearly labeled in an audit pack.

Tools to Make it Simple

• Accounting Software: QuickBooks, Xero, Zoho Books – automate bookkeeping, reconciliations, and reports.
• Fixed Asset Tools: Asset Panda, Sage Fixed Assets – track assets and calculate depreciation automatically.
• Cloud Storage: Google Drive, Dropbox, Hubdoc – store and organise invoices, receipts, and audit files.
• Reconciliation & Reporting: BlackLine, FloQast, Fathom – automate reconciliations and generate reports.
• Task & Compliance Trackers: Trello, Asana, AuditFile – manage audit prep tasks and filing schedules.

How Depreciation and Amortization Affect EBITDA and Cash Flow?

Although they do not affect actual cash flow, depreciation and amortization are non-cash costs that lower reported net income. Because EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) adds these back together, it shows how profitable a business is doing without taking into consideration asset wear or intangible amortization. 

How E2E Accounting UK Helps With Depreciation & Year End Services

E2E Accounting UK streamlines intricate year end procedures so you can concentrate on managing your company. In accordance with UK accounting regulations, our staff makes sure that depreciation and amortization are calculated, posted, and reconciled accurately. To facilitate seamless year-end closings, we offer thorough fixed asset management, automated schedules, and thorough reports that are ready for an audit, at the same time for your investors and bankers assurance.

E2E Accounting UK provides customised solutions that guarantee your books are always clear, in compliance, and prepared for inspection, regardless of the system you use, QuickBooks, Xero, or another one.

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