Depreciation is how the tax system acknowledges that business assets wear out over time. The ATO provides two standard methods for depreciating business assets — diminishing value (DV) and prime cost (PC) — plus simplified options for small businesses. Choosing the right method and applying it consistently matters both for tax minimisation and for producing financial statements that accurately reflect the business's asset values.
Prime Cost vs Diminishing Value: The Core Difference
Both methods depreciate an asset over its effective life as determined by the ATO's tax ruling TR 2024/1 (updated annually). The difference is the pattern of deductions.
Prime cost spreads the deduction evenly over the asset's effective life. The annual deduction is calculated as:
(Cost ÷ Effective life in years) × (Days held ÷ 365)
A $10,000 laptop with an effective life of 4 years generates a $2,500 deduction each full year under prime cost.
Diminishing value applies a fixed rate to the opening written-down value each year, not the original cost. The DV rate is 200% divided by the effective life. For that same laptop: 200% ÷ 4 = 50% per year DV rate. Year 1 deduction: $5,000. Year 2: $2,500. Year 3: $1,250. And so on.
The DV method front-loads deductions. In the early years, it produces larger deductions and lower taxable income. Over the full life of the asset, both methods claim the same total deduction (the full cost minus any residual value) — DV just delivers more of it sooner.
When to Choose Each Method
The choice depends on the client's circumstances:
Prefer diminishing value when the client has taxable income now and would benefit from larger deductions in early years. Capital-intensive businesses replacing equipment regularly — hospitality, manufacturing, transport — often benefit from DV because the front-loaded deductions offset peak-earning years.
Prefer prime cost when the client has losses or low income now and expects to be more profitable in later years. Even deductions stretched into the future are more valuable if the future marginal rate will be higher. This applies to early-stage businesses investing heavily before they turn profitable.
Important: Once you choose a method for an asset, you cannot switch. This is a common misconception — the choice is locked in at the time of first use. Document the method selected for each asset in the depreciation schedule.
ATO Effective Life: Where to Find It
The ATO's TR 2024/1 (and its predecessor rulings) lists the effective lives for thousands of asset types. Some common ones:
- Office furniture: 10 years (DV rate 20%)
- Laptops and computers: 4 years (DV rate 50%)
- Motor vehicles: 8 years (DV rate 25%)
- Manufacturing equipment: varies widely by type, 5–20 years
- Commercial fit-out: typically 7–10 years for individual components
Where an asset is not specifically listed, taxpayers can self-assess effective life based on the expected period of use in their specific circumstances. Self-assessed effective lives must be supportable if the ATO queries them — keep the reasoning on file.
| Asset type | Effective life | DV rate |
|---|---|---|
| Office furniture | 10 years | 20% |
| Laptops and computers | 4 years | 50% |
| Motor vehicles | 8 years | 25% |
| Manufacturing equipment | 5 to 20 years | varies widely |
| Commercial fit-out | 7 to 10 years | by component |
Low-Value Pool: Simplifying Small Assets
Assets with an original cost or opening adjustable value of less than $1,000 can be allocated to a low-value pool rather than depreciated individually. The pool itself attracts a 37.5% DV rate for assets added during the year and 18.75% in the first year (the half-year rule). This simplifies depreciation schedules significantly for businesses with many small assets.
Once an asset enters the low-value pool, it stays there even if the pool balance falls below $1,000. The pool continues until its written-down value reaches zero.
Note that the low-value pool is separate from the small business immediate deduction thresholds described below — they are different mechanisms.
Small Business Simplified Depreciation
Entities that qualify as small businesses (aggregated turnover under $10 million) can use the simplified depreciation rules. Under the current rules, assets costing below the instant asset write-off threshold (check the ATO website for the current threshold, as it changes regularly with budget announcements) can be immediately deducted rather than depreciated over time.
Assets above the threshold go into the small business pool, which operates on a 15% rate in the first year and 30% thereafter — simpler than maintaining individual asset depreciation schedules. The small business pool must be written off entirely when its balance falls below the threshold amount.
Bookkeeping Implications: Keeping the Depreciation Schedule Clean
From a bookkeeping perspective, the depreciation schedule is a critical document that links asset registers, accounting records, and tax returns. Ensure that:
- Every depreciable asset has an entry in the depreciation schedule with: acquisition date, cost, effective life, method selected, opening WDV, depreciation for the year, and closing WDV.
- Assets disposed of during the year are removed from the schedule and any balancing adjustment (taxable profit or deductible loss on disposal) is recorded.
- Additions part-way through the year are pro-rated using the days-held formula.
- Assets held for mixed business and private use are only depreciated on the business-use percentage.
Software like Xero and MYOB handle most of this automatically, but the bookkeeper still needs to enter the correct effective life, method, and business-use percentage at the asset setup stage. Defaults are not always appropriate.
Depreciation is not glamorous bookkeeping — but errors in the depreciation schedule compound over years and can produce material differences in both tax liability and reported net assets. Getting it right from the first year saves significant correction work later.