The concept of depreciation is quite simple. For example, let' s say you purchase a truck for your business. The truck loses value the minute you drive it out of the dealership. The truck is considered an operational asset in running your business. Each year that you own the truck, it loses some value, until the truck finally stops running and has no value to the business. Measuring the loss in value of an asset is known as depreciation.
Depreciation is considered an expense and is listed in an income statement under expenses. In addition to vehicles that may be used in your business, you can depreciate office furniture, office equipment, any buildings you own, and machinery you use to manufacture products.
Land is not considered an expense, nor can it be depreciated. Land does not wear out like vehicles or equipment.
To find the annual depreciation cost for your assets, you need to know the initial cost of the assets. You also need to determine how many years you think the assets will retain some value for your business. In the case of the truck, it may have a useful life of only 10 years before it wears out and loses all value.
Straight-line depreciation is considered to be the most common method of depreciating assets. To compute the amount of annual depreciation expense using the straight-line method requires two numbers: the initial cost of the asset and its estimated useful life. For example, you purchase a truck for $20,000 and expect it to use it in your business for 10 years. Using the straight-line method for determining depreciation, you would divide the initial cost of the truck by its useful life.
The $20,000 becomes a depreciation expense that is reported on your income statement under operation expenses at the end of each year.
For tax purposes, some accountants prefer to use other methods of accelerating depreciation in order to record larger amounts of depreciation in the early years of the asset to reduce tax bills as soon as possible.
You also need to check the regulations published by the Internal Revenue Service and various state revenue authorities for any specific rules regarding depreciation and methods of calculating depreciation for various types of assets.
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