Bad Debts, Depreciation, Amortization and Depletion

If you've read this article and the ones related to it, let's now move on to a set of expenses you can deduct for tax purposes.

1.) Bad Debts

Bad debts arise when goods are sold on credit, but not paid. Normally, when goods are sold on credit the seller/creditor is said to have made a profit. However, the seller/creditor suffers a loss if he can no longer collect from his customers/clients because of bankruptcy or other causes. To protect the seller from such losses, he can deduct them for tax purposes if he meets the following requisites:

a.) The debt is connected to the seller's business, profession, etc.

b.) It has been determined to be worthless

c.) It was written off/charged off during the taxable year

Note that mere doubtfulness doesn't  justify deductibility. If there is a possibility that the debt can still be paid then it's not deductible. And if a bad debt was written off in one year but the seller was able to recover in the next, the recovered amount will form part of the seller's gross income for the year when it was collected. The recovery of a bad debt is taxable if the seller benefited from it and is not taxable if he didn't benefit from it. 

Worthless debts from unpaid salaries, wages, rentals and similar items are deductible only if they were included in the return of the year they were written off.

2.) Depreciation

Depreciation is the allocation of a part of the cost of a permanent, tangible asset on regular periods as a form of deductible expense. To avail of depreciation as an expense, the taxpayer must show that:

a.) The asset is used in the taxpayer's profession, trade or business

b.) It has a limited useful life.

The following kinds of property are subject to depreciation:

a.) Furniture and fixtures

b.) Returnable containers

c.) Leasehold improvements

d.) Machinery

e.) Patterns and dies used for regular products

f.) Equipment

g.) Buildings

There are many ways of computing depreciation, but the easiest is known as the "Straight-line method." It looks like this:

Annual Depreciation = Cost - Scrap Value

                                   Estimated Useful Life

To illustrate, let's say here's a guy called Bryan who owns a commercial building valued at Php10 Million that has an estimated scrap value of Php500,000 and an estimated useful life of 20 years. We calculate:

= 10,000,000 - 500,000

    20

= 475,000

So the building has a depreciation expense of Php475,000 a year. Note: if a building is renovated, its useful life becomes longer.

3.) Amortization

This is depreciation's equivalent with regard to intangible assets. So now we're talking about copyrights, patents, trademarks, franchises leaseholds and goodwill. The formulas for calculating depreciation can also be used in amortization, with a slight twist. For example, the "Straight line method" will look like this:

Annual Amortization = Cost /Useful Life

4.) Depletion

Depletion is a deductible expense covering the extraction of natural resources (referred to as "wasting assets" because they're irreplaceable.) Timberland, mineral lands and oil, gold, silver and ore deposits are covered by depletion. Depletion is calculated this way:

Depletion Rate = Cost of Wasting Asset/Estimated Resource Deposit

Let's say Billions Mining, Inc. owns land containing silver deposits and is valued at Php1,000,000 with an estimated 25,000 tons of silver in it, the computation will look like this:

= 1,000,000/25,000

Depletion Rate = Php40/ton

Therefore, if 100 tons of silver are extracted, that's:

40 x 100 = 4,000

So Billions Mining can claim Php4,000 as depletion expense from the 100 tons of silver it extracted.