The IT accounting / finance best practices are going to vary somewhat from company to company, from state to state, and from nation to nation- due to standards and guidelines on depreciation of assets and taxes on assets. It is also going to differ somewhat based on how conservative or liberal the CFO wants to be on depreciation expense and the useful life of a given asset. It is very important that CIO partners with CFO and agree upon a standard depreciation schedule for different asset classes, and manage IT asset & IT investment systematically & flexibly.
1. A Tale of Two Sets of Accounting
As many organizations operate on an integrated global basis, they operated with two sets of accounts. The first was local country-based accounts complying with local rules on depreciation etc. The second were global management accounts that applied the policies the Board decided as appropriate for the effective running of the business. Consequently, the depreciation amounts in the local tax accounts and the global management accounts were often different.
- Two different IT Finance Planning: Some IT executives do two different finance planning: 1) industrial and 2) fiscal. Matching the two, tells the CFO when, for real, some assets will have to be renewed, so it gives the finance department the right information about when to get ready for the money to buy something. While the fiscal plans show up in the annual report, so it tells how much your company owns assets and value. There’s misunderstanding of different types of accounting. While doing industrial accounting, you should use the actual number of fiscal years you intend to use the asset, both are needed. But the business is actually run on the industrial analysis, the fiscal one, although, are formally and legally needed, If the industrial analysis shows that your business is unsustainable (for instance) it is ACTUALLY unsustainable, even if the fiscal analysis might show the opposite in many cases.
- The other refinement some organizations applied is to use consistent "plan" currency exchange rates for the whole financial year so that any over or under-spending was not obscured by exchange rate fluctuations. The Finance treasury department then managed and reported on issues caused by exchange rate fluctuations. Some look at using purchasing power equivalent exchange rates to eliminate distortions due to local currency strength or weakness to avoid distorting decisions upon where to hire people, based on temporary currency variations.
2. Why IT normally depreciates IT Asset in 3 to 5 years? Why not use it more?
Finance and regulatory requirements don't always match. The more business critical an element is, the better your understanding of reality needs to be; the less any replacement or updating matters, the easier it is to obey arbitrary regulation or rules. Although you have to always use two measures-industrial planning and fiscal planning. Depreciation from the industrial planning standpoint should always end with the market value of the asset and follow the characteristic function of the specific asset (a computer will lose more value in the first year of use than in its third). The industrial analysis doesn't have an impact on deduction of income statements. It is only involved in estimating the actual cash flow needed to run your specific business model.
- There are functional and financial reasons why three-five years is a de facto time frame for IT devices. At the end of a three-year depreciation cycle, end user devices like PCs will be very considerably below the current market spec both in cost and performance terms. For the same outlay as three years ago, you will naturally get significantly more capability, and the volume of moaning from staff about the slowness of their aging kit becomes a hidden "cost". For servers and storage devices, after three years, most vendors ratchet up the maintenance charges, sometimes extortionately. This is annoying but understandable because the cost to them of sourcing spares the cost to maintain current expertise and the likelihood of actually needing to do repairs all go up over time.
- Depreciation is an accounting measure. It is important to depreciate in order to assess the assets market value, but even more importantly, depreciation is used as a deduction on income statements, therefore, lowering the amount of tax a company will pay. Depreciating the asset does not mean the asset itself is useless. So feel free to continue to use it if it drives business growth and/or keeps the business running.
- Are In-house Software Assets? The other question IT need to agree upon with CFO is whether or not you are going to treat any software developed for internal use as an asset - in essence, treating these expenses as capital instead of operating expenses. If your CFO wants to do this, then, only using this accounting treatment on major projects that will be used for at least three years, as the last thing you want to do is to put a new asset on the books and have to take a large write-off a year later because the business unit is no longer using it.
- IT depreciation life cycle: Depreciation is not always a precise indicator of a useful life of IT asset. Understandably, the accounting department has a job to do and depreciation schedules have to be consistent because that is a big part of what accounting is all about - consistency. In reality, the common policy of three-year write-downs has fed a vendor marketing, pricing and support strategy that complements the practice. Combine Moore's Law on cost/capability, accountants and vendors creating a self-fulfilling prophecy, and you will almost certainly be replacing most kit on three to five-year cycle.
3. IT Budget & Investment Decision
As many companies have multiple book sets due to the growing international nature of the business and the adoption of international accounting rules, they may not make a purchasing decision based solely on depreciation. It might have been a consideration, but if the financial team is worth their salt, they will understand the nature of technology purchases and they will have strategies to deal with the relevant issue.
- "Bow wave" effect on the IT budget such that an asset that was affordable in year one could cause significant budget problems in year two as there is twice the amount of depreciation on that asset. The solution to this would have been running a budget for the current and following years. Alternatively, it might have been better to have taken full year depreciation in the first year. This treatment may have had to be different in the financial and tax accounts (as opposed to management accounts) to comply with legislation and standards.
- How can accounting practices deal with emerging IT service subscription model: such as cloud, mobile, computerization of IT, for example, on Cloud services, the accounting treatment depended on the contract? If IT made an upfront payment for 12 months service, this was shown in the IT financial report as 12 equal charges spread over the term of the contract (even if this went beyond the financial year). Similarly, for other contract periods such as twenty-four months upfront payment split into 24 equal charges. So it had much the same effect as depreciation.
- Accounting practices are different from long-term budgeting needs, the practice of assuming a three-year lifespan of IT asset both for accounting and planning purposes are taken for some mature companies and assume that any cost-effective usage beyond three years is a bonus. But, don't focus on the accounting rules when it comes to IT decisions. You can't serve your end users and stakeholders well by limiting your outlook in that way.
3. What about Product End of Life & End of Support?
As part of the proposal for any major purchase, IT needs to include the cost of support (which was accounted by charging it in equal monthly installments over the duration of the support contract), work on the basis that if you couldn't afford the cost of support, you couldn't afford the purchase.
- Support fees are measured upon depreciation, in fact, support cost increases with the aging of the item normally of the same or very similar amount of the depreciation, causing a slight increase in the TCO that should be presented by the IT executives to the board as a good reason to innovate and renew the infrastructure on a planned timeline.
- Manage asset value via adding the maintenance costs. For instance, when you buy a server, it's CapEX item only until when its warranty covers for the maintenance. Thereafter, when you start paying for the maintenance, an OpEx item appears. The combination of the two items of expense draws a diagram that clearly tells you when would be the right moment to update the asset.
Companies are highly dependent on IT executives who make the proposal to change/ replace the technology based on the need of the business. Thus, IT should continue to review upon the ROI of existing IT investment, whether depreciated life cycle is completed or not; whether new technology/ product mature enough in the business market to adopt. Applying the right procedures and policies to asset management allows IT to create a realistic budget with few surprises, and keep best practice to adapt to “continuous changes.”