5 Things About Depreciation Every Business Owner Must Know

5 Things About Depreciation Every Business Owner Must Know

Admit it! As a small business owner, you’ve always been fascinated by the numbers-packed columns in the financial reports your accountant tirelessly prepares for you.  Show me the money, baby!

But the accountingese is where you draw the line, right?

You may be familiar with a couple of accounting terms and that’s it.

I’m here to tell you, though, that being familiar with accounting can actually prove helpful and rewarding. 

When you know accounting, you understand your business financials in-depth and you can make waaay better business decisions.

I had a chat with Anél Keet, an amazing corporate financial analyst, about a pretty hot but complicated accounting topic: fixed assets and depreciation.

Anél revealed the 5 things about fixed assets and depreciation every small business owner must know and so must you!

So without further ado, here they are.

1. What’s an asset? Fixed assets, current assets, expenses, oh my!

Let’s start with the basics. What’s an asset?

Simply put, whatever you buy for your business is considered an asset

There are 2 categories of assets, fixed assets, and current assets

If your asset is bought with the intention of being used over a long period of time, like machinery, a vehicle, computer equipment, or even a building,  then it’s a fixed asset and you can categorize it as such on your balance sheet.  

If, on the other hand, your asset can be converted into cash in a short period of time, usually within a year, then it’s considered a current asset. Current assets include your bank account, inventory, or even other investments.

Lastly, an expense is the amount of resources that’s been already consumed in your business over an accounting period.

The rule of thumb to record an asset as a fixed asset or as an expense is a base amount that you can learn from your tax practitioner. 

For example, in South Africa, the amount of 5,000 rands is the base below which all costs are considered expenses. However, you can edit your fixed asset register to include fixed assets that cost less than the base amount, like 3,000 rands or 4,000 rands. 

If you’re not sure which category your asset falls under, always ask your tax practitioner.

And don’t forget to be as detailed as possible when you have doubts about something you recorded in your books. 

Including comments and detailed descriptions and, of course, keeping your receipts, help your tax practitioner sort everything out at the end of the year. 

2. What’s depreciation?

As Anél explained, depreciation is the process of deducting the cost of the assets over a period of time in your income statement, instead of dumping it all at once as an expense

So, that period of time that you deducted over is the useful life of that asset. 

Useful life is how long you think you’re going to be using that asset. 

If you think you’ll probably be using the laptop you bought for about six years, your depreciation annually would be the entire amount you spent on it, divided by six years. That way, you move a portion of the cost of your assets from your balance sheet to your income statement as depreciation.

To determine the useful life of the asset for depreciation, consult with your country’s tax authorities

How assets and expenses affect tax time 

So, characterizing an asset as a fixed asset or as an expense affects your tax time. 

From a tax perspective, you will be able to deduct the full expense against your taxable income for the year, while, if your asset is depreciated over a period of time, you deduct the portions from your taxable income every year. 

3. Straight-line depreciation vs. Diminishing balance method of depreciation 

There are two types of depreciation, straight-line depreciation and diminishing balance method of depreciation

The former is the most commonly used, so we’re going to focus on that. The latter is practically never used, as it’s a tad more complicated.

  • The straight-line method splits your depreciation into equal parts over the useful life of your asset. If, for example, your laptop costs $2,000, you divide its cost by the useful life (let’s say it’s 5 years) in equal parts, therefore your depreciation per year will be $400.
  • The diminishing balance method allows you to write off more depreciation in the earlier years of your asset because some people consider their assets more valuable at the earlier stages of the assets’ life, so you can write off more at the beginning. 

4. What is accumulated depreciation?

Now, let’s talk about accumulated depreciation.

Accumulated depreciation is the sum of all the depreciation of a specific asset you’ve written off since you purchased it.

In the example above, in your year one the laptop’s cost is $2,000 and the depreciation expense is $400, hence an accumulated depreciation of $400. The carrying value, which is the value of your asset on your balance sheet, equals the cost of the asset minus the accumulated depreciation. So, your carrying value, in this case, is $1,600.

Next year, your cost still remains the same, your depreciation expense again is the same as the previous year ($400) but now your accumulated depreciation is $800 ($400 that you wrote off last year plus $400 you’re writing off this year). 

This makes your carrying value $1,200, which is the cost minus the accumulated depreciation, giving you your balance sheet value.

5. Adding assets you already have onto your business: yay or nay?

As Anel says, getting an asset you paid for out of your pocket and not out of your company bank account onto your balance sheet is difficult.

It’s always a good idea to purchase any assets you use in your business from your company bank account to get a tax-deductible.  

You could, however, take the expense to capital as an investment and add your asset on the journal entry instead of a loan. Be sure to double-check with your tax practitioner before you try it on your own though.

Did this small intro into fixed assets and depreciation intrigue you enough to want to dip your toes into accounting?

If your answer is yes, then sign up for my accounting course, Master Your Finances today!

You’ll unlock the mysteries of accounting and bookkeeping and you’ll gain the financial freedom you’ve always dreamed of.

Once you enroll, you’ll be part of our awesome Facebook group, where you’ll learn about more accounting topics from guest experts like Anél.

So, what are you waiting for? 

Let’s dive into the world of accounting and bookkeeping together! 

PS: Looking for more ways to lower your tax bill? Download our FREE tax deduction list today. Write off more expenses and pay less tax!

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