Depreciation is something that every entrepreneur should understand and use. It is on of the easiest ways for a small business to maximize profits with in house accounting control. Entrepreneurs are your neighbors, the teenager who mows your lawn, and maybe even you. If you have always dreamed of starting your own business you probably are not going to jump straight into a situation where you have 50 employees and an accounting firm to handle all of your day to day book entries, so when you are just starting out it is important to take the time to learn how to account for all of your financial transactions is an easy and concise manner. Depreciation is one of those key factors that many new business owners over look due to the idea that it is complicated accounting structure. It is important to remember that there are tax advantages to depreciating equipment purchases and that of course means money, which is the grease used to turn the wheel of business.
Depreciation is calculated by estimating a salvage cost for any piece of equipment then subtracting that amount from the cost of the asset. This depreciation value, however, is only the beginning. The real work comes with the method of depreciation. There are two main types of depreciation. The first is straight line depreciation. In this method that value left over after subtraction is then divided by the life of the asset. It is important to understand that the asset or piece of equipment may in fact last much longer that the depreciation schedule but it is generally considered more cost efficient to depreciate an asset over a specific number of year, thereby front loading the tax advantages. With straight line depreciation the depreciation value subtracted from the asset value remains constant every year. While the second is the accelerated depreciation method, sometimes called the double declining method, uses a percentage to calculate the asset depreciation value each year. By doing this the asset is depreciated much faster than with straight line depreciation. In the end it is up to the business to decide which is more beneficial to the company and what method is the right choice. Also, it should be noted that any method of depreciation can be used for different pieces of equipment. If a landscaping company buys a skid-steer and a snow plow on the same day the company could very well put the skid-steer on a straight line schedule and the snow plow on a accelerated schedule. Both types of depreciation schedules have more than one way to actually depreciate an item but for the purposes of this article straight-line will be the focus; just for ease of use.
On a companies balance sheet depreciation is represented with a depreciation expense account and an accumulated depreciation account. The accumulated depreciation account is a contra asset and the balance in this account is the cumulative total of the depreciation. So if we assume that our skid-steer cost $25,000 dollars and is depreciated over 10 years with a resale value of $5,000 dollars at that time then each year a credit of $2,000 dollars is made to the accumulated depreciation account and a debit of $2,000 dollars is made to the depreciation expense account. As an expense depreciation will count towards the total for any fiscal years and help a company balance out the expense of purchasing a new piece of equipment.
Finally if the whole idea of having to set a future resale value and an estimation of asset life seems to be just too much when dealing with all of the other day to day work of running your own business then you can always turn to the IRS asset depreciation schedules called the Modified Accelerated Cost Recovery System (MACRS). With MACRS every asset falls into a classification and is depreciated over a specified number of years. This takes all of the guess work out of depreciation and can be found at http://www.irs.gov/publications/p946/index.html . The only thing to keep in mind when using the IRS depreciation schedule is that it does not take into account any resale value so the asset is depreciated completely and any resale value has to be accounted for later.
It is important for any small business to maintain accurate accounts with the advent of technology we now have the ability to access more and more information with ease and to utilize complicated functions that were often done by hand in years past, but that does not exclude the necessity to know and understand the fundamentals of a subject. While many things in accounting are of course important simple things like depreciation of an asset can greatly improve a small company’s balance sheet and income statement. By depreciating you can maximize the value of newly purchased equipment. All you have to do is decided the life of a piece of equipment and what you plan to resell it for, subtract the resale value from the initial purchase cost then divided that number by the total “life†of the asset. This will give you an annual amount to depreciate, and if you really want to take the guess work out MACRS is always available from the IRS.
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Orignal From: The Importance of Depreciation in a Small Business
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