Assets and depreciation
Prime cost method
The prime cost method spreads an asset's cost evenly over its effective life, giving the same deduction each year based on a fixed percentage of the original cost.
The prime cost method, sometimes called the straight line method, is one of two ways to work out the decline in value of a depreciating asset. It assumes the asset loses the same amount of value every year. The deduction is a fixed proportion of the cost, determined by the asset's effective life, for each full year the asset is held and used.
The formula is the asset's cost multiplied by the number of days you held it as a decline-in-value period divided by 365, multiplied by 100% divided by the effective life in years. For an asset with a five-year effective life, the rate is 20% of cost for a full year. For an asset with a ten-year life it is 10%. Because the cost is the starting point and does not change, the deduction stays level until the asset is fully written off.
In the first year, the deduction is reduced if you did not have the asset ready for use for the full year. You count the days from the date you start to hold it as ready for use to the end of the income year. In later years the deduction is a full year unless the asset is sold, lost or stops being used for the business. If use is partly private, the deduction is reduced by the private portion.
The method suits assets whose usefulness is steady through time, such as furniture or fit-out items, and it is simple to forecast. It gives smaller deductions in the early years compared with the diminishing value method, which can matter for cash flow and timing of tax benefits. You choose the method for each asset, and generally you cannot switch it later, so it is worth thinking about at the start.
GST sits separately. A GST-registered business generally claims the whole GST credit on the purchase in the BAS for the period of the tax invoice, while the income tax deduction under the prime cost method is spread over the years. The cost used in the formula is generally the GST-exclusive amount for a business that claims credits. When the asset is sold, GST is usually payable on the sale price if the business is registered.
A common mistake is applying the percentage to a reducing balance rather than the original cost, or forgetting to apportion in the first year by days. Keep an asset register to track each asset. This is general information only, so confirm your situation with the ATO or a registered tax professional.
Worked example
A registered business buys a machine for $12,100 including GST on 1 July, so the GST-exclusive cost is $11,000 and the credit is $1,100. Assume an effective life of 10 years. Prime cost deduction for a full year is $11,000 x 365/365 x 100%/10 = $1,100. The same $1,100 is deducted each year for 10 years, a total of $11,000.
Practical tips
- Apply the rate to the original cost each year, not to a reducing balance. The deduction stays the same.
- In the first year, count the days from when the asset was ready for use to the end of the income year.
- Keep an asset register so you can track the method chosen for each asset, since it generally cannot be changed.