Depreciation

Concept and Definition of Depreciation

Depreciation is a term that—apart from translations such as Abschreibung (amortization/depreciation)—is primarily used in legal and economic contexts in connection with the loss of value of movable and immovable assets. The concept describes the gradual consumption of value of an item over its economic useful life. Depreciation is particularly important for accounting, tax assessment, and contractual risk allocation.

Depreciation arises in commercial law, tax law, and insurance law, and encompasses the process of value reduction caused by wear and tear, aging, technological progress, or other influencing factors.

Systematic Classification of Depreciation in the Legal System

Commercial Law Relevance

In commercial law, depreciation forms the basis for commercial amortization (§ 253 para. 3 HGB). Companies are required to record the anticipated consumption of value of their assets systematically and appropriately for each period in their business records. The correct valuation of individual items, especially installations and equipment, is crucial for balance sheet clarity and accuracy.

Accounting Treatment

• Depreciation Methods: In principle, depreciation effects are represented by either straight-line or declining-balance methods.
• Extraordinary Depreciation: Value losses exceeding the planned depreciation are accounted for through extraordinary write-downs (§ 253 para. 4 HGB).
• Relevance for Annual Financial Statements: The recognition of depreciation directly affects the company’s value as reported on the balance sheet and the annual result.

Tax Law Aspects

Tax law also regulates the treatment of depreciation. The Income Tax Act (EStG) is particularly relevant here.

Tax Depreciation and Assessment Bases

• Depreciation for Wear and Tear (AfA): Section 7 of the EStG sets out how fixed assets may be depreciated for tax purposes.
• Depreciation Rates and Periods: The permissible depreciation rates and useful lives are often stipulated by AfA tables.
• Impact on Tax Burden: The reduced values resulting from depreciation lower the taxable profit.

Special Cases

• Immediate Write-off of Low-value Assets
• Write-off due to Extraordinary Technical or Economic Wear and Tear

Insurance Law Significance

In insurance law, depreciation is central to determining the current value of items, e.g., in property insurance.

• Current Value: The amount to be compensated by an insurer in the event of loss or damage is usually determined on the basis of the current value, taking depreciation into account, and not on the original new value.
• Restoration and Replacement Value: Depending on the insurance contract, other value concepts may also apply, but depreciation always plays a role in determining the amount of compensation.

International Perspective and Legal Harmonization

Significance in International Accounting Standards

International accounting—particularly IFRS (International Financial Reporting Standards)—contains corresponding rules for the consumption of value (depreciation). According to IAS 16, depreciation (write-down) must be properly carried out over the entire economic lifetime of an item. The aim is the allocation of expenses to the correct periods and reflection of the actual asset value.

Differences between National Legal Systems

Depending on the jurisdiction, the definitions, methods, and legal effects of depreciation may vary; this particularly concerns statutory depreciation periods, tax recognition, and treatment of residual values.

Depreciation in Contracts and Tort Law

Contractual Treatment

In contracts—such as in purchase or leasing law—consideration of depreciation plays a role in determining compensation payments and residual values.

• Leasing Contracts: The calculation of leasing installments is regularly based on the expected loss of value (depreciation) of the leased asset over the contract period.
• Purchase Contracts with Rescission or Reversal: In this case, a refund is often made after deduction of depreciation for actual use.

Liability and Compensation Law

In the event of damages (e.g., after a traffic accident), the amount to be compensated is frequently based on the current value, taking the loss in value into account.

Methods for Determining Depreciation

Straight-line Depreciation

Annual, even allocation of the loss in value over the entire useful life.

Declining-balance Depreciation

Greater depreciation in the initial years, decreasing over time.

Performance-based Depreciation

Depreciation is based on actual use (e.g., machine operating hours).

Special Depreciations

In special cases, such as extraordinary wear and tear (accident, theft).

Legal Consequences of Faulty Consideration of Depreciation

If depreciation is not properly taken into account in balance sheets, tax returns, or damage calculations, serious legal consequences may arise:

• Accounting Offenses: Missing or incorrect depreciation may constitute balance sheet fraud within the meaning of commercial or criminal law.
• Subsequent Tax Assessments and Sanctions
• Disputes regarding insurance benefits and contract processing

Summary

Depreciation is firmly rooted in law: in commercial law it governs the accounting and valuation of assets, in tax law it affects taxable profit determination, and in insurance law it is crucial for compensation calculation. The methods and consequences of depreciation are regulated by numerous laws and regulations and require careful and legally sound application to avoid breaching legal obligations.

Source Reference:

• Commercial Code (HGB)
• Income Tax Act (EStG)
• International Financial Reporting Standards (IFRS)
• Insurance Contract Act (VVG)
• BGB

This article is for informational purposes only and does not constitute individual legal advice.

Frequently Asked Questions

How is the commencement of depreciation legally determined?

The commencement of depreciation is legally closely linked to the time the asset is put into operation or used in the business. Under German tax law, particularly § 7 para. 1 EStG, depreciation generally begins in the month in which the asset is actually acquired or produced and put into business use. This is independent of payment or delivery, but depends solely on the moment of use. In commercial law, according to § 253 para. 3 HGB, actual use is also decisive. If an asset is temporarily not used, for example because necessary permits are missing, the start of depreciation is postponed accordingly. If a used item is purchased, the time of first business use is also crucial for the start of depreciation. Proper documentation of commissioning is particularly essential for audits.

When is extraordinary depreciation legally permissible?

Extraordinary depreciation (impairment) is legally permissible if there is a permanent loss in value of an asset. According to § 253 para. 3 sentence 3 HGB and for tax purposes according to § 6 para. 1 nos. 1 and 2 EStG, extraordinary depreciation is required as soon as the recoverable amount of an asset falls below its book value and the impairment is expected to be permanent. This may be the case, for example, in the event of technological innovations, damage, market changes, or other circumstances that clarify the impairment. The value loss must be appropriately and transparently documented as part of the individual valuation obligation. The taxpayer is responsible for providing evidence, as the tax authorities critically examine these factors during assessment or audit.

What is the legal significance of the AfA table?

AfA tables (depreciation for wear and tear) do not constitute law, but are ministerial administrative guidelines that play a significant role in determining the usual useful life of assets. According to the case law of the Federal Fiscal Court (BFH), they are binding for the tax authorities, while taxpayers may deviate from the table values for good cause, provided they can prove the different useful life (§ 7 para. 1 sentence 2 EStG). In the event of a dispute, the taxpayer must support the deviating depreciation period with factual arguments and evidence (opinions, technical reports, etc.). Thus, the AfA table provides a secure legal basis but is not conclusive.

What legal regulations apply to the depreciation of low-value assets (GWG)?

Special tax regulations apply to low-value assets (GWG) under § 6 paras. 2 and 2a EStG. Assets with acquisition costs up to 800 euros net (since 2018) can be written off immediately in full (immediate write-off). Alternatively, for assets with acquisition costs between 250 and 1,000 euros, there is an option to include them in a collective item depreciated over five years on a straight-line basis. Compliance with these rules must be clearly and continuously evident from the company’s bookkeeping and fixed asset register, while also observing the legal requirements for documentation and proof.

How should subsequent acquisition or production costs be treated in terms of depreciation?

Subsequent acquisition or production costs are legally to be added to the original acquisition or production costs if they improve the asset beyond its original condition, make it usable, or extend its useful life (§ 255 para. 2 HGB, § 6 para. 1 no. 1a EStG). They are not immediately deductible as business expenses, but must be allocated over the remaining useful life of the asset. Legally, all subsequent costs must be documented and directly assigned to the respective asset. Proper allocation is mandatory for tax returns and audits and must be evidenced by documentation.

What legal particularities apply when an asset is disposed of from business assets?

The disposal of an asset may occur for various reasons, such as sale, withdrawal, scrapping, or loss. Legally, depreciation ends when the asset is removed from business assets (§ 7 para. 1 sentence 4 EStG). In such cases, any residual book values must be written off with profit or loss effect. Special rules apply to withdrawals, where the withdrawal value is considered a notional sales price (§ 6 para. 1 no. 4 EStG). For documentation purposes, the exact timing and reason for disposal must be recorded, e.g. by disposal notes, withdrawal or scrapping protocols.

How do legal changes to depreciation methods affect existing assets?

Legal changes, for example, the introduction or abolition of declining-balance depreciation or changes to straight-line depreciation, generally only apply to assets added after the relevant provisions take effect. For assets already in use, there is a legitimate expectation that the regulations in force at the time of acquisition will remain binding, unless the legislature explicitly orders a retroactive change. However, such retroactive changes are exceptional, subject to strict requirements, and require express legal provisions. The tax administration regularly publishes application decrees in this regard, which companies must follow.