Business Guidance and Knowledge for the Small Business Entrepreneur
Depreciation is the process of allocating an asset purchase over its life expectancy. It is most commonly used to expense a prorated portion of an asset purchase such as heavy equipment, vehicles, buildings, and other large ticket items. These articles include GAAP and tax depreciation.
The key to this investment is the asset allocation model. A common thread that binds all of them is that the asset side of the balance sheet is fixed assets intensive. Basically, more than 85% of the assets are fixed in nature.
Depreciation is a form of an allowance for the wear and tear (exhaustion) of property used in a trade or a commercial enterprise. The idea is to match as well as possible the actual use (utility) of the asset to its change or reduction in fair market value due to that utility.
There are many transactions in accounting requiring the accountant to use estimates for the respective debits and credits. The following five lessons cover how estimating is performed with depreciation, payroll benefits, bad debts, warranties and extraordinary items. This lesson explains why estimating is needed and used in business.
The fixed assets turnover rate is another activity ratio whereby an income statement financial characteristic is compared to a balance sheet asset section. In this case, comparing adjusted sales against historical cost of fixed assets. This financial business ratio is only effective for business operations that are fixed asset intensive. With service based industries like carpet cleaning, professional firms and medical practices this particular ratio is impractical.
Every day bills arrive from vendors that are mere repetition like the electric or phone bill. They basically recur every so often (mostly monthly). The bookkeeper must create a new entry as a part of his/her daily functions. This repetition consumes time and is a nuisance.
n a pure cash only operation, the profit as reported on the income statement would also be cash flow from operations. But modern-day business is not pure in how it is conducted. Companies agree to pay suppliers at a later time, payroll is weekly or monthly, benefits that are paid in the future are offered to employees, credit is extended to customers; the list can go on and on.
Amortization is similar to depreciation whereby an asset’s cost is allocated to the expense over time. There are several differences with amortization. Amortization is used with intangible assets and the method is almost always straight line. As a bookkeeper it is your job to maintain the amortization schedules, report the information correctly and interpret the results for management.
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.
When a small business purchases fixed assets two financially based opposing forces come into play. The first is the financial reporting desire to present information in a fair manner so management can make good financial decisions. The opposing force has to do with taxation. Here the business desires to report less profit to reduce the tax obligation.
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.
