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. Continue reading ‘The Importance of Depreciation in a Small Business’ »