What is Depreciation?

Accounting as you may have heard, has a lot of terms. Some of them are complicated words for simple things. Others are simple things that have become exceptionally complex in application. Depreciation falls into the latter category.

Depreciation exists because in accrual accounting it is important to spread costs over the period in which they apply. We are talking strictly theory right now.

The idea being that if you buy a truck for your fleet at a cost of $10,000, you will not use that truck up that day. The cash doesn’t leave the bank, and you exhaust the usefulness of that truck on the day you bought it. That truck is going to be useful for quite some time. But how much time?

This is where things get iffy. Because what started as a simple idea we now have to put on paper. Because for how long will that truck be useful? And is it more useful at different times?

Because of these complexities, and because the government, through the IRS wants to encourage business investment, they have a set of rules on how to depreciate an asset, as well as some bonuses for buying assets, bonus depreciation being one of them.

None of that applies to your books, for bookkeeping purposes. So, how do you determine the useful life? A simple method is to match it to the tax life. Truck being 5 years. And how to spread it out? Evenly or accelerate the depreciation to be greater at the beginning of the assets life compared with the end. There are methods for all of these.

As a business owner, you probably don’t care about all this accounting fluff. These are non-cash expenses, why should you care about them, you have real bills to pay now. Another way that business owners can use depreciation is to facilitate capital asset investment decisions. If you know that your assets are only going to last for 5 years, than the amount you are depreciating you need to be tucking away every month. Because that cash is going to go out the door at the end of that time.

This is just one way.

Does this help? Let us know below.

Best of luck.

Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as financial or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate legal professional, financial adviser or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.

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