Depreciation Methods in Switzerland

As your businesses acquires assets, it is essential to understand the concept of depreciation and how to record it. Depreciation is a means of accounting for the decrease in the value of assets over time due to usage, wear and tear, obsolescence, etc. In this article, we will explore the various depreciation methods used in Switzerland, why depreciation is important, the types of depreciation, methods for calculating depreciation, and how to record depreciation.

What Is Depreciation?

In accounting, depreciation refers to the estimated decrease in value of an asset over time. Put another way, it is an accounting method which allocates the cost of an asset over its useful life as opposed to just the year in which it was bought. These two definitions effectively mean the same thing, because the decrease in value of an asset during a year also represents the portion of the cost of that asset which is ‘incurred’ in that specific year.  

Depreciation is recorded as a non-cash expense that reflects the loss of value of an asset due to usage, wear and tear, and obsolescence. Depreciation is not only applied to tangible assets such as buildings, vehicles, and equipment, but also to intangible assets such as patents, copyrights, and trademarks.

Why Account for Depreciation?

Accounting aims to accurately reflect a business’ financial situation and keep track of their income and expenditure. In doing this, it is important to record an estimation of depreciation in the financial statements because it allows businesses to reflect the true value of their assets more closely. Without accounting for depreciation, the value of a company’s assets would be overstated, leading to an incorrect representation of the company’s financial situation.

Accounting for depreciation also has potential tax benefits. Depreciation is recorded as an operating expense in the books of the business, which reduces their taxable income and therefore results in lower taxes owed by the company.

Types of Depreciation

There are various ways in which an asset can lose value over time. Examples include:

• Normal wear and tear,
• Obsolescence,
• Physical damage,
• Expiry of IP rights,
• Changes in market conditions or demand,
• Damage due to weather, natural disasters, etc.

These forms of depreciation can be broadly categorised into two main types: scheduled depreciation and unscheduled depreciation.

Scheduled vs. Unscheduled Depreciation

Scheduled depreciation is a reduction in the value of fixed assets that is foreseeable, so that the depreciation amount is planned and fixed in advance. Ordinary wear and tear, depreciation due to the passage of time, etc. fall into this category. Depreciation is calculated each year on the basis of the acquisition cost of the asset, its expected useful life and the specific depreciation method used (straight-line or declining balance).

Unscheduled depreciation refers to unexpected and unplanned losses in the value of an asset. This can occur due to natural disasters, accidents, sudden obsolescence, unknown defects, etc. In this case, the company must recognise an impairment loss based on the best estimate of the loss in value that has occurred. In addition, the adjusted (reduced) value of the asset becomes the new basis for calculating the scheduled depreciation amounts in the planned depreciation schedule (especially when using the declining balance method of depreciation).

Methods for Calculating Depreciation

There are two main methods for calculating depreciation: Linear depreciation and degressive depreciation.

Linear Depreciation

Linear depreciation is the simplest and most commonly used method of depreciation. It calculates depreciation as a fixed percentage of the asset’s original acquisition cost over its estimated useful life. The asset is therefore depreciated by the same amount each year.

For example, if a company purchases a machine for CHF 10,000 with an expected useful life of 10 years and no salvage value, the annual depreciation would be CHF 1,000 (10,000 / 10). The depreciation is recorded as an expense on the income statement (debit entry) and reduces the asset’s book value on the balance sheet (credit entry).

Degressive Depreciation

The method of degressive depreciation is based on the premise that an asset’s value decreases more rapidly in the early years of its life and slows down as it ages. In other words, the amount written off as depreciation decreases every year. Degressive depreciation can be said to be a closer reflection of reality but is more complicated to calculate and record.

There are two types of degressive depreciation: declining balance and sum-of-the-years’-digits.

The declining balance method is the more common of the two types of degressive depreciation methods. It differs from the method of linear depreciation, in that instead of calculating the depreciation each year as a fixed percentage of the asset’s acquisition value, it calculates it as a percentage of its current book value– that is, it’s value after accounting for each subsequent depreciation entry.

For example, let’s suppose the same company in the previous example instead uses a 20% declining balance depreciation rate on the machine with an initial cost of CHF 10,000:

• The first year’s depreciation would be CHF 2,000 (20% of the initial cost of CHF 10,000), leaving a book value of CHF 8,000.
• The second year’s depreciation would be CHF 1,600 (20% of the book value of CHF 8,000), leaving a book value of CHF 6,400.
• The third year’s depreciation would be CHF 1,280 (20% of the book value of CHF 6,400), leaving a book value of CHF 5,120. And so on…

As you can see, this method results in higher depreciation expenses in the early years of the asset’s life, reflecting the fact that assets generally lose value at a faster rate in those years. It is important to note that the depreciation rate is usually chosen to be approximately twice that of the corresponding linear method.

The sum-of-the-years’-digits method is another, less common type of degressive depreciation. It calculates depreciation based on the sum of the years of an asset’s useful life.

For example, if a machine has a useful life of 10 years, the sum of the years’ digits would be 55 (1+2+3+4+5+6+7+8+9+10). In the first year, the depreciation would be 10/55 of the asset’s cost, in the second year, 9/55, and so on until the final year, when the depreciation would be 1/55 of the asset’s cost.

Comparison of Different Depreciation Methods

Both the linear method and degressive methods of depreciating assets are used in Switzerland, and each have their relative advantages and disadvantages, as well as situations where they are more appropriate and useful.

Linear depreciation is easy to calculate and understand, which is why it is the most widely used method even though it might not accurately reflect reality.

Linear methods are used for most low-value fixed assets, where the small discrepancy of the linear method from reality does not result in a significant difference in the depreciation calculation. Here, the costs and effort of using degressive depreciation methods are not worth the small improvement in accuracy.

Degressive depreciation methods, on the other hand, better reflect the fact that an asset may lose value at a faster rate in the early years of its life and are therefore seen as a more accurate way to account for an asset’s actual depreciation. The main downside of degressive depreciation methods is that they can be more complex to calculate and understand. It is also important to note that, although they may be a closer reflection of reality, no method of calculating depreciation can perfectly represent the actual loss in value of an asset over time, which depends on a multitude of constantly changing factors.

Degressive depreciation methods are usually used for higher-value fixed assets which tend to lose value much more rapidly in the early years of life, and where a greater level of accuracy is important and warrants the extra cost and effort involved.  

Recording Depreciation

There are two ways to record depreciation in the books of the business: directly or indirectly.

Recording Depreciation Directly

Directly recording depreciation involves debiting the depreciation expense account and crediting the respective asset account, therefore directly reducing the book value of the asset. The depreciation account is closed to the profit and loss account at the end of the year, and the asset is recorded at book value (cost price less depreciation) in the balance sheet at the end of the year.

Recording Depreciation Indirectly

Indirectly recording depreciation involves creating a contra asset account on the balance sheet, usually named “Provision for Depreciation” or “Accumulated Depreciation”. The depreciation is again debited to the depreciation expense account; however, it is now this contra asset account that is credited instead of the actual account of the asset being depreciated. This method does not directly reduce the asset’s book value, making it more complex to understand.

When Does Depreciation Start and End?

It is important to note that depreciation starts on the day the asset is purchased or acquired, and not only on the day of first use. The calculation is also rounded up to the nearest month. I.e., if a company purchases an asset on July 8^th, the whole month of July would be used to calculate the depreciation, and so there would be 6 full months of depreciation incurred in that calendar year.

Depreciation ends when an asset is fully depreciated or disposed of. The asset’s useful life and expected salvage value are used to determine the length of time over which depreciation will be recorded.

Swiss Regulations on Depreciation

Swiss law requires companies to record depreciation in their financial statements to accurately reflect the value of their assets. Companies are required to follow the Swiss Code of Obligations (CO), the Federal Direct Tax Act (DBG), or other recognized standards, such as Swiss Generally Accepted Accounting Principles (GAAP) when recording depreciation.

Art. 62 of the DBG stipulates the following points on depreciation, among others:

1. Depreciation of assets is allowed, provided it is recorded in the books of the business or in special depreciation tables if there is no commercial accounting.
2. Depreciation should be calculated according to the actual value of the individual assets or distributed in accordance with their expected useful life.
3. Depreciation on assets that have been overvalued to compensate for losses can only be recorded if revaluation is permitted under commercial law.
4. Depreciation on production costs is added back to taxable income if they are no longer justified.

Furthermore, the DBA also sets out standard depreciation rates on the book values (i.e., degressive depreciation rates) of different types of assets. It is important to note that these figures only serve as guidelines, and there may also be cantonal deviations. The linear depreciation rates on the acquisition value are determined by halving the corresponding degressive rates.