Depreciation Explained and What to Remember About It

Confusing turmoil is a common product of love, war, and tax depreciation. Tackling the latter entails comprehending the idea of treating certain large business purchases differently than ordinary expenses like rent and advertising. Buildings, computers, equipment, and furniture are examples of fixed assets. Their cost is deducted over time, not when they’re acquired.

Small purchases don’t require depreciation. Defining what qualifies as small depends upon your business size, accounting practices, and depreciation policy. Generally, small businesses depreciate any single item that costs at least $2,500 and will last more than one year. A $199 chair is a normal expense; a $5,000 equipment unit is depreciated.

Depreciable asset purchases are not an expense on the income statement. Instead, asset costs appear on the balance sheet. Depreciation is the expense category where cost is transferred over time from balance sheet to income statement. As depreciation expense is added to the income statement, the same amount is subtracted from assets on the balance sheet. This subtracting causes a negative number in the asset account called accumulated depreciation. Original costs for assets stay in a separate account.

In principle, an asset’s cost is depreciated over the useful life that it generates income. In reality, however, depreciation periods normally correspond with whatever is allowed by the tax rules for various asset types. Accelerated depreciation – permitting higher depreciation in initial years – contrasts with straight-line depreciation using equal percentages each year. Sorting out specifics about period and method is an accountant’s job, but every business owner should grasp the general process of recording assets and depreciating costs.

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