One of the differences between book income and taxable income is depreciation. In general Section 168 of the Internal Revenue Code allows businesses to accelerate their depreciation for tax purposes. This increases the expenses of the business thus reducing profit for tax purposes.
Accelerated depreciation is customarily found with tax depreciation, it allows the small business owner the opportunity to take additional (accelerated) depreciation expense and reduce their respective tax obligation for that tax year.
Depreciation is the process of allocating the initial capital outlay for fixed asset purchases over time to the income statement. The basic principle with depreciation is that any fixed asset has a predetermined lifetime based on time, usage or fair market value. Therefore, a fair and equitable allocation of the initial purchase price is applied to each time period. Your job as the bookkeeper is to assign depreciation expense to the respective asset and record the entry as a function of daily operations.
Accounting’s primary purpose is to measure economic activity. There are several different methods to determine the economic value generated in your business each year. In accounting this is referred to as sets of books. There are four basic sets of accounting books. Each has a different purpose and end goal.
When it comes to depreciation, no two businesses are alike. Unlike traditional straight line depreciation where the asset value is costed out to depreciation expense in equal increments over a given life expectancy, accelerated depreciation expenses the cost at higher values during the earlier accounting periods and at a lower amount towards the last half of the asset’s life expectancy.
Any tangible item not consumed within one accounting cycle (typically a year) and providing long term utility is referred to as a Fixed Asset. Traditional images include manufacturing equipment, tools, transportation vehicles, buildings and utility related systems (sewage systems, power grids, power plants and dams). In accounting, these assets are recorded to the balance sheet as ‘Fixed Assets’.
The Internal Revenue Service sets the depreciation allowance based on the Code as promulgated by Congress. The most commonly referenced section is 179. This is a form of accelerated depreciation allowing the small business owner the opportunity to take a large expense deduction and reduce their tax obligation immediately.