Let’s start off with a little joke. “What did the accountant say to his business client who insisted that his company’s return get filed, ASAP? …….I depreciate if you didn’t.”
Corny puns aside, depreciation is an important concept in accounting and tax. In accounting, depreciation is a method that is used to spread out the cost of an asset, like a vehicle, over its useful life expectancy, rather than expensing it all out in one year and throwing your accounting records off. In tax, the depreciation amount is often used as a deduction and may allow you to recover some of the costs on certain property used in a business.
Depreciating Value
Assets like vehicles, furniture, equipment, and buildings may be depreciated. Generally, it should have a useful life beyond a year and have a salvage value after it lasts beyond its useful life. Land cannot be depreciated though since its treatment is handled more uniquely. In accounting, there are different types of depreciation when recording the depreciation of assets, such as straight-line, double declining balance, and units of production. For example:
Jack purchased a $13,000 vehicle for his business with a salvage value of $2000 after 5 years. He uses the straight-line method of depreciation ($13,000 cost – $2,000 salvage value / 5 year useful life) and calculates a depreciation of $2,200 each year.
Other depreciation methods like double-declining balance allow for more depreciation in its first few years, or “units-of-production” allow for depreciation based on the usage of an asset, such as a factory machine producing items. The method you choose can affect how much depreciation applies each year and matters to your business.
Depreciation & Tax
The amount that you depreciate on your assets is reported for your taxes and operates like a deduction, such as reporting your depreciation on business assets to the IRS on Form 4562. However, calculating your depreciation within the required guidelines becomes a topic in itself, such as the MACRS depreciation system used by the IRS.
Depreciation and the methods your business chooses to depreciate its assets are essential things to consider as your business grows. It can affect your own accounting records in the expenses reported and potentially your profit & loss reports. For tax, depreciation may potentially affect how much you ultimately owe to the government. Depreciation gets tricky, and business owners can make the right choices by having the right advisors, like us here at MiklosCPA. We support small and emerging business clients of assorted industries with their tax and accounting needs. Learn how we can help your business & schedule a call with us! Also check out our social media pages for more useful “good-to-know” articles like this one.