Why Depreciation Matters for Your Books and Your Tax Return
Depreciation is the systematic allocation of the cost of a tangible fixed asset — a delivery van, a building, office equipment, machinery — over the period it is expected to generate revenue for the business. Rather than expensing the full purchase price in the year you bought the asset, you spread that cost across its useful life. This matches the expense to the revenue the asset helps produce, which is a core principle of accrual accounting under the Philippine Financial Reporting Standards for Small and Medium-sized Entities (PFRS for SMEs) that most Philippine corporations and cooperatives follow.
Depreciation is also a tax matter. Section 34(F) of the National Internal Revenue Code (NIRC), as amended, allows businesses to deduct a "reasonable allowance for the exhaustion, wear and tear, and obsolescence" of property used in trade or business. This deduction directly reduces taxable income, which in turn reduces the income tax due — whether your business pays the 25% regular corporate income tax, the 20% preferential rate available to corporations with net taxable income not exceeding ₱5,000,000 and total assets not exceeding ₱100,000,000 (excluding land), or graduated individual income tax rates for a sole proprietor. Land is never depreciable, since it does not wear out or become obsolete; only the building and improvements on it are.
One practical caveat for self-employed individuals and professionals: if you availed of the 8% income tax option or the Optional Standard Deduction (OSD), you cannot separately claim depreciation, because both alternatives already replace itemized deductions with a flat computation. Depreciation only reduces your taxable income if you are using itemized deductions. You should still maintain a fixed asset schedule for your books and for BIR examination purposes even if you are not using it as a tax deduction that year.
The Straight-Line Method: The Default Approach
Straight-line depreciation is the simplest and most widely used method in the Philippines because it is easy to compute, easy to audit, and produces a consistent, predictable expense every period. The formula is:
Annual Depreciation = (Cost of Asset − Estimated Salvage Value) ÷ Estimated Useful Life
Worked example: Suppose a small logistics business buys a delivery van for ₱1,000,000. Management estimates the van will be usable for 5 years and can be sold for an estimated ₱100,000 (salvage value) at the end of that period.
Annual depreciation = (₱1,000,000 − ₱100,000) ÷ 5 = ₱180,000 per year, or ₱15,000 per month.
Each year, the business records ₱180,000 as depreciation expense on the income statement, and the van's carrying value on the balance sheet (cost less accumulated depreciation) declines by the same amount, until it reaches ₱100,000 at the end of Year 5. If the van is placed in service partway through the year, depreciation is typically prorated for the number of months it was actually in use, rather than a full year.
Other Depreciation Methods Recognized by the BIR
Section 34(F) does not lock businesses into straight-line depreciation. It allows any method that is reasonable and consistently applied, provided the total amount depreciated over the asset's life does not exceed its depreciable cost (cost less salvage value). The most common alternatives include:
- Declining balance (including double-declining balance): Applies a fixed percentage to the asset's remaining book value each year, producing higher depreciation expense in early years and lower expense later. Using the same van (cost ₱1,000,000, 5-year life), the double-declining rate is 2 ÷ 5 = 40%. Year 1 depreciation = 40% × ₱1,000,000 = ₱400,000. Year 2 = 40% × (₱1,000,000 − ₱400,000) = ₱240,000, and so on, until the book value approaches the ₱100,000 salvage value, at which point depreciation stops.
- Sum-of-the-years-digits: Also front-loads expense, but using a declining fraction based on the sum of the years in the asset's life (for a 5-year asset, the digits 1 through 5 sum to 15, so Year 1 uses 5/15 of the depreciable cost, Year 2 uses 4/15, and so on).
- Units of production: Ties depreciation to actual usage rather than time — useful for machinery. For example, a machine costing ₱500,000 with a ₱50,000 salvage value and an estimated total output of 90,000 units has a depreciation rate of ₱5 per unit. If it produces 10,000 units in a given year, depreciation expense for that year is ₱50,000.
Accelerated methods (declining balance and sum-of-the-years-digits) reduce taxable income more in the early years of an asset's life and less later on, which can be useful for cash flow planning, but they add complexity to your bookkeeping and require careful, consistent documentation to withstand BIR scrutiny.
Useful Life, Salvage Value, and Choosing a Method
The NIRC does not prescribe a fixed table of useful lives for every asset type the way some other countries do. Instead, the useful life you assign should reflect your actual, reasonable expectation of how long the asset will remain economically usable in your business, taking into account physical wear, technological obsolescence, and your own maintenance and replacement practices. In practice, many Philippine businesses and their auditors converge on similar ranges by asset class, though these should always be reassessed against your own operating conditions rather than treated as fixed rates.
Salvage value is your best estimate of what the asset will be worth, or can be sold for, at the end of its useful life. The old requirement of a fixed minimum salvage value (commonly cited as 10% of cost) is no longer enforced as a rigid rule; businesses may adopt a reasonable estimate consistent with their financial reporting policy, including zero if the asset will have negligible resale or scrap value.
Whichever method you choose, consistency is essential. Changing depreciation methods or useful life estimates from year to year without a documented, reasonable basis is a common flag in BIR examinations and also runs against financial reporting standards, which require disclosure and justification whenever an estimate is revised. Most small and medium businesses find straight-line depreciation the most defensible and least burdensome choice, reserving accelerated methods for specific assets where the pattern of economic benefit genuinely front-loads, such as rapidly obsolescing technology.
Recording and Reporting Depreciation in Your Books
Depreciation is recorded through a simple monthly or annual journal entry: a debit to Depreciation Expense and a credit to Accumulated Depreciation, a contra-asset account that reduces the carrying value of the related fixed asset without altering its original cost. This keeps your fixed asset register transparent — you can always see the original cost, total depreciation to date, and remaining book value for every asset.
A properly maintained fixed asset schedule (showing cost, acquisition date, method, useful life, salvage value, and accumulated depreciation per asset) supports the depreciation expense claimed in your income tax return and is typically required to substantiate your books during a BIR audit. It also feeds directly into the Notes to Financial Statements that accompany your Audited Financial Statements filed with the BIR and, for SEC-registered corporations, with the Securities and Exchange Commission, which require disclosure of the depreciation methods and useful lives used for each major asset class. In Kontabler, once you set up an asset's cost, method, and useful life, monthly depreciation is computed and posted to your books automatically, and the running schedule feeds directly into your financial statements and BIR-ready reports — removing the manual spreadsheet work that often causes errors or missed entries at year-end.
Because depreciation directly affects taxable income, and because rates, thresholds, and specific BIR administrative issuances can be updated from year to year, businesses and their accountants should periodically reconfirm current rules on the BIR's official website or with a licensed accountant before finalizing depreciation policy for a new fiscal year, particularly for asset classes with unusual useful-life questions or high-value acquisitions.
Depreciation does not create cash, but it does reduce the taxable income against which your income tax is computed — which is why an accurate, consistently applied schedule is worth the setup effort.
Frequently asked questions
Can I choose any depreciation method for my business?
Yes. Section 34(F) of the NIRC allows straight-line, declining-balance, sum-of-the-years-digits, units of production, or any other reasonable method, as long as it is applied consistently and the total depreciation over the asset's life does not exceed its depreciable cost.
Is land depreciable?
No. Land is never depreciated because it does not wear out or become obsolete. Only the building and improvements built on it can be depreciated.
Do I still need a depreciation schedule if I use the 8% income tax rate or Optional Standard Deduction?
You cannot claim depreciation as a separate tax deduction under the 8% option or OSD since both replace itemized deductions, but you should still maintain a fixed asset schedule in your books for accounting purposes and possible BIR examination.
Is there a fixed BIR table for useful life by asset type?
No official fixed schedule exists for most asset classes; useful life should be a reasonable estimate based on your actual expected use of the asset, though common industry practice ranges (such as roughly 5 years for vehicles) are often used as a starting reference.
