If you are reading this as an experienced accountant, explaining what depreciation does is unlikely to be necessary. Just as a brief reminder, it’s all about spreading the cost of an asset over its expected useful life. If you purchased an asset for $3,600 with an expected life of three years, using the straight-line method, that would mean a charge of $1,200 per year to the profit and loss.
Depreciation Policies - What methods should be used?
There can be a lot of factors to consider when deciding what method of depreciation is going to be used. Some examples are:
- What has been done historically (so to maintain consistency)
- Values of assets purchased
- The business structure – Incorporated Company or Sole Proprietor
- The Accounting Rules Being followed which could vary in different countries
- Following allowances for tax purposes or true financial accounting
It’s the last point above that really needs to be given a lot more consideration as it is often overlooked. When tax returns are being completed – whether it’s the UK, the US, Canada, anywhere worldwide, the allowable expenditure for items of a capital nature can be claimed as a cost in the year of purchase. If this is the case, is depreciation necessary? The simple answer is still yes.
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Accounting for Capital Items in line with tax allowances – To Make Tax Preparation Easier
Governments around the world will have different limits when it comes to the amount of expenditure of a capital nature can be claimed when taxes are prepared. This could be 100% of the cost or using different methods of accelerated cost recovery against the assets purchased.
Accounting for these allowances in the bookkeeping software could possibly expedite the preparation of a tax return, but are you really doing your client any favors? The answer here is no. In today’s financial climate this is more important than ever to get right.
Treating capital expenditure of say $5,000 as an expense or using accelerated depreciation methods against assets that could cost $1m, will have a far from positive effect on the profit and loss report. The balance sheet is not going to look as strong as it should, and this will not help a business if they are seeking investment or applying for a loan. This will also be important if a director/business owner is trying to apply for a mortgage.
Annual Adjustments -v- Monthly Provisions
Real-Time Accounting is here, and it’s important that depreciation is accounted for each month. Annual adjustments made in the last month of the financial year will make that month look out of line with previous months – consistency is key when preparing management reports of any kind.
Do you like the idea of automation?
If you’d like to learn how to automate fixed assets when using QuickBooks Online or Xero, save a stack of time, and move a step closer to true ‘Real-Time’ Financial Accounting, please join us on this webinar next week. Or visit nettTracker to learn how fixed assets can be made easy….very easy!