A Brief Guide On Understanding Depreciation For Business Owners

Depreciation does more than just cut your tax bill. It is a tool to help you estimate the actual net income of your company and have an improved awareness of your long-term expenses. Depreciation is a valuable tool for accounting balance and for planning how much of your earnings should go towards replacing equipment, machinery, and other items that depreciate over time. 

In Solana Beach, California, businesses follow generally accepted accounting principles (GAAP) to account for depreciation expenses. This typically involves spreading the cost of an asset over its useful life, reflecting its declining value accurately on financial statements. For more information on depreciation, contact a CPA in Solana Beach, California.

What should business owners know about depreciation? 

The types of assets that can be depreciated for the purpose of accounting are controlled by rules set out by the IRS. The IRS says that for an asset to be depreciable, it requires to:

• Be owned by you
• Be employed in your business or to generate revenue,
• Have a defined functional life
• Expected to live over a year.

The most common categories of depreciable assets include machinery and equipment, buildings, cars, furniture and other office supplies, computers, and other electronics, machinery and equipment, and certain intangibles like computer software, copyrights, and patents.

Which assets are exempted from depreciation?

Any asset that is unlikely to wear out, become outdated, or run out of use cannot be depreciated under IRS regulations. Furthermore, you cannot depreciate:

• Collectibles (such as artwork, coins, antiques, etc.)
• Land
• Personal properties
• Any asset that has not been used for more than a year

Accounting uses a number of depreciation tactics. The following are the four main types of depreciation.

• Straight line depreciation

The simplest and most direct method of depreciation is this one. It splits the value of an item evenly throughout a number of years, so for each year that the asset is valid, you pay the same amount.

For small companies with simple accounting systems or those where the business owner sets up and submits the tax return, straight-line depreciation is an achievable option.

• Double declining depreciation

With this method, also known as declining balance depreciation, you can deduct a significant portion of an asset’s value at the time of purchase and lesser amounts over time. This is an excellent option for businesses, including small enterprises that have a lot of initial costs and need extra cash, that would like to recover a more significant portion of the asset’s worth up front rather than having to wait for a certain amount of years.

• Sum of the years’ digits depreciation

The double-declining method and the sum of the years’ digits (SYD) depreciation are similar in that they both use an accelerated depreciation calculation. SYD determines a weighted proportion based on the asset’s remaining useful life rather than reducing the book value.