(Money Matters) What is Depreciation? - Kasfia Rashid

Kasfia Rashid - “Money Matters with Kash the Bookkeeper”

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Introduction: 
Hello! Welcome to Money Matters- Ask the bookkeeper series, the accounting show answering burning accounting questions! You know, the ones you would only ask your best bookkeeping buddy! 

Each show will have one main question from the audience with supporting questions from my various travels. Have a question to ask? Don’t be shy, step right on up! You can submit your questions directly to Hello@kashthebookkeeper.com! You may hear your question aired live across the globe! Last week, we discussed the first tough lesson of entrepreneurs- the cash reconciliation. 

This week’s main question is: What is “depreciation”? We covered the concept last season, but there is so much more to depreciation than meets the eye. In short: Depreciation is the reduction in value of an asset with the passage of time, due to wear and tear/use of the asset. 

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Show Objectives - The Why

Have you ever purchased a new car or know anyone who has? Personal finance gurus advise buying a late model used car over a new car due to first-year depreciation.
According to carsdirect.com A new car depreciates or loses value almost immediately after you drive it off a dealer's lot. As a quick rule of thumb, a car will lose between 15% and 20% of its value each year according to Bankrate.com. This phenomenon is not limited to cars, but applies to every business asset other than cash. 

Depreciation allows an asset to be expensed in pieces every year. The net amount ( cost - depreciation) is known as the “book value” of the asset. The amount of cash the asset can be exchanged for is known as the “market value”. The difference between the book and market values will determine the gain or loss on that asset. As a business owner, we need to understand what the market value of our assets are, in case we need to sell them to cover our expenses or liabilities. This becomes pivotal when we are looking for funding or investors. Keeping detailed notes on depreciation is important not just for federal tax purposes, but personal property taxes as well. 


What You Need to Know - The What

Depreciation can get complicated when you start involving numbers, so it is easier to focus on the big picture instead of getting bogged down in the technicalities. 

Here is the big picture: The result of all those complex depreciation calculations is that the government will pay for a portion of the cost of the assets you acquire to use in your business. That payment comes to you through a reduction in the taxes you pay over one or more years after you purchase the assets.
There are three methods commonly used to calculate depreciation.

They are:

1. Straight line method :Annual Depreciation expense = (Asset cost – Residual Value) / Useful life of the asset
2. Unit of production method :Per unit Depreciation = (Asset cost – Residual value) / Useful life in units of production
3. Double-declining balance method: twice the Straight Line method 

 
Three main inputs are required to calculate depreciation:

1. Useful life – this is the time period over which the organisation considers the fixed asset to be productive. Beyond its useful life, the fixed asset is no longer cost-effective to continue the operation of the asset.
2. Salvage value – Post the useful life of the fixed asset, the company may consider selling it at a reduced amount. This is known as the salvage value of the asset.
3. The cost of the asset – this includes taxes, shipping, and preparation/setup expenses.

Depreciation allows a portion of the cost of a fixed asset to be expensed in the year of purchase and every year for a set period of time. The period of time and the allowable annual portion of depreciation depends on the method of depreciation used. BUT WAIT.. there’s more! Depending on the type of asset, the location of the asset, and the year in which it was purchased, it could be a candidate for SPECIAL DEPRECIATION! *duunn dun dunnnnnnnnnn!* 

Fortunately, the IRS publishes tables that simplify the depreciation calculations. And most accounting software for your business comes with a depreciation program included or available as an add-on.

What You Need to Do​​ - The How

Let’s stripe down the mechanics of depreciation into simple steps. After purchasing something for your business:

1. Determine if a purchase should be classified as an asset or as an expense. Once it has been determined it should be an asset…. 
2. Write down when it was purchased, the cost of the purchase ( how much money actually left the bank account), what was purchased, and why. 
3. Use the handy tax tables to determine the various amounts of depreciation you are able to claim on that asset
4. Record depreciation every year until the asset’s worth is zero 
5. Keep all paperwork related to the purchase, sale, or transfer of any assets
6. If you acquired an asset via a transfer - record the cost of the trade as the value of the asset. 

If you want more detailed information on the actual calculation of depreciation check out these helpful guides:

• https://corporatefinanceinstitute.com/resources/knowledge/accounting/types-depreciation-methods/ 
• https://www.irs.gov/publications/p946
• https://money.howstuffworks.com/personal-finance/personal-income-taxes/how-to-use-irs-depreciation-tables.htm
• https://vlcpa.com/articles/understanding-how-depreciation-works-here-s-the-big-picture/64 
• https://www.profitbooks.net/what-is-depreciation/ 

Additional Resources 

1. Check out Kash’s Youtube Playlist: Bookkeeping basics for small business owners. 
2. Get this affordable guide to reconciling any account quickly and accurately! Click here: https://kashthebookkeeper.com/paid-resources/ and scroll down to Reconcile any business or personal account in 4 easy steps!! On Sale now! 
3. Want more KASH? Sign up for the free newsletter! 

Shows: 
Previous: What is a cash reconciliation? 
Next:  How do I build business credit?

​Written by Kash the bookkeeper  
Check out the last QuickBooks Online Tutorial you will never need here! 

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