Depreciation accounting can seem a bit overwhelming, but once you learn a little bit about how it works and why it’s necessary you’ll see it’s fairly straightforward and easy to understand.
Of course, there are some intricacies and it can be a bit more complex depending on the type of business you are in. But here is a basic overview so you can become familiar with the process.
The basic depreciation definition is allocating the cost of a particular asset over the course of the anticipated life of that asset.
This includes anything that will not last forever, like a building, equipment, trucks, computers, fixtures, etc.
Even though a company will often pay for that item outright, as far as accounting purposes are concerned, the expense of that item will be spread out through the “lifespan” of that item.
Assets will not all be treated the same way, and there are several depreciation methods that accountants will employ.
Straight line depreciation is more commonly used, and means that each
year the same amount or percentage of the asset’s value is depreciated,
not including the salvage value.
Let’s say your company bought a computer system and it cost $15,000. It is expected to last 10 years. Here is how the asset depreciation would look:
Cost of Asset:
Less: Salvage Value
Years of estimated useful life:
Depreciation expense per year:
So your depreciation rate would be $1,000 per year for 10 years in this example.
Accelerated depreciation is as the name suggests…the asset’s cost is allocated in a much faster manner, with more of the cost being allocated at the beginning and less at the end. The total amount of depreciation remains the same, but the rate at which it takes place is different.
In the depreciation accounting example above, the year one amount will be the highest, and every year after that the amount recorded will be less throughout the 10-year period. There are several depreciation methods for this, including SYD, 150% declining and double-declining.
So now you can answer the question what is depreciation accounting and how does it work. It’s simply a way to spread the cost of any asset you have over the life of that asset, removing its residual value from the equation.
If you have any questions about how depreciation works, talk to your accountant. He or she will be familiar with all of the particulars that apply to your business. Together you will be able to figure out the best way to record depreciation for your company.
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Over 90% of small businesses fail or change ownership within the first five years.
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