Friday, 18 November 2011

Understanding Depreciation: It May Be Easier Than You Think

Depreciation is defined as a portion of the cost that reflects the use of an asset during an accounting period. An asset is something that has a useful life of more than a year. An accounting period is usually a month, quarter, six months or a year. Say you bought a desk for your office on January 1 of $ 1,000 and determined that the office had a lifespan of seven years. The use of an accounting period of one year and the "straight line" depreciation method, the portion of the cost would be depreciated by one-seventh of $ 1000 or $ 142.86.

Most counters will not roll their eyes and shudder when the topic of "depreciation" comes from. This is where the line is drawn in the sand. Depreciation is too complicated to try to understand, or so it seems to many. But is it really? Without doubt, the definition of depreciation mentioned above is not so difficult to understand. If you look closely you'll see that there are five pieces of information necessary to determine the amount of depreciation you can deduct in one year. They are:

-The nature of the item purchased (the desk).

-Date item was introduced (Jan 1).

-The cost of the item ($ 1,000).

-Use the time the item (seven years).

-The method of depreciation to be used (straight-line depreciation)

The first three are easy to understand, the next two are also easy but require a little research. How can you imagine the life of an article? Let me back for a moment. It is "depreciation", which is based on real life of a point, and not the IRS version of what constitutes the life of a point. A company that deals with the precise allocation of costs so you can get a true picture of the net book depreciation is used in its financial statements.

However, the taxation of companies is required to use the IRS method. The IRS may be shorter or longer useful life of assets lead to more or less the depreciation write-off. Higher devaluation, firms will pay less taxes. Long and short is that you end up creating a record of accounting and tax accounting. Therefore, smaller companies, who are not interested in the precise measurement of their net profit use the IRS method of accounting. This means that all you have to look only at IRS Publication 946 to find the life of a particular item.

The last piece of information you need can be found by determining the depreciation method used. In most cases, this will be one of two methods: the "straight line" method or accelerated method called "double declining balance" method briefly review these two methods.:


This is the simple method mentioned in the definition above. Just take the cost of the item, divide it with the useful life and you have the answer. Yes, you will need to adjust the damping for the first year you place the item in the service and for the last year, when you remove the element of service. For example, if your depreciation for one year was $ 150 and you place the item in use at April 1 $ 150 divided by 12 (months) and multiply $ 12.50 by 9 (months) for $ 112.50. If you deleted the article, February 28 then your deduction will be $ 25.00 (2 x $ 12.50).

Double-declining balance

The idea of ​​this method is when the item was purchased new, you can use it more in earlier years of his life, therefore, justified higher depreciation deduction in previous years. In this method, simply to share the cost of living in the straight-line method. Then explain that the result 2 (two) in the first year. The second year, to reduce the cost of the asset and depreciation. Next, divide the result of life and tell the result of 2, and so on for each remaining year.

But wait! You do not need to do this. The IRS provides a table of books arranged by the percentages of each of the two different methods. Not only that, they created a special first-year "contracts", which takes you purchased outside of the plan on June 30. This is called the half-year contract. The idea is that you may have purchased a few items before June 30, and some later. So, to make it easier to find, taking the upper and lower amounts of depreciation, all media.

In fact, the IRS does not even call it depreciation anymore. They call it "cost recovery". To tell the truth. This is a political tool. Congress of give and take. They have played this system for years. If you want to promote business growth, will reduce the life of the property so that companies can achieve a higher write-downs. If you are not in the mood, which will extend the life of the asset. A good example is the 39 years of commercial property set for life. This means that if you rent the building your business and make improvements, these improvements have been removed for more than 39 years. Now Congress is preparing a bill to drop up to 15 years Leasehold improvements.

Before December 31, 1986 we had ACRS or Accelerated Cost Recovery System. Currently we have MACRS or modification of the system accelerated cost recovery. Each time Congress tweaks the rules they give it another name.

Remember there are different schedules for different properties. For example, in real property are amortized over 27 years and a half, and commercial property are amortized over 39 years. In addition, if more than forty percent of your total fixed asset purchases were made in the last quarter of the year, so you must use a mid-quarter convention. This convention assumes that purchases made in the last quarter of the year was conducted on November 15. This prevents you from buying a large piece of expensive equipment, Dec. 31 and treat it as if it had purchased on June 30 and get a greater impairment.

Understanding how basic depreciation may be useful for the small business owner because it helps to know the tax implications when planning purchases of capital goods.