If I were to ask four people about any depreciation, I probably get four different answers:
- Amount of liquidation of property
- Payment to replace property
- Calculator for tax reduction or
- Way to allow inflation.
All four would be wrong. State Auditors are not known to explain it well – which may take into account the above misunderstandings – but I will try to explain it as follows:
- You will understand something more about your accounts,
- You can impress the bank Your Account Manager and Others With Your Accountability,
- You'll understand why your depreciations are in your accounts and budgets but not in cash flow statements
- You can understand and prepare your budgets better and
- You'll be able to understand your accounts – and take better decisions about – companies that you may need to buy or invest in.
The explanation of depreciation begins with cost and assets:
Everything you spend on your business is what we call:
- You pay your phone bill so you have a telephone cost.
- You pay for a new car so you have the property, the car.
We treat both auditors to treat them differently. Why is it?
The reason is time.
- All expenses that are "used" within a year are overhead – phone costs are used and you have nothing to show. There is a cost.
- All expenses not used per year (your car lasts longer than one year, hopefully) is called an asset. By the end of the year you still have a car to show for it.
Expenses go into Income Tax * and reduce profits and taxes. The income statement shows your income and expenses.
Assets go to Balance Sheet * and have no effect on profits. Balance sheet shows what you owe and own at any time.
Now, what happens with property?
Thus, you buy your car and its cost is included in the balance sheet together with land, buildings, factories, equipment and other assets. Balance sheet shows you what assets you own … but not how much they are worth. These assets are in your balance sheet until your accountant does something about them … and what he or she does is write off them.
As you know, all assets except the country wear and finally decide to exist. So we leave land in your balance sheet at the original cost, until you sell it. We do not write off land.
Any other assets will be out or "used" somehow – like your phone bill, but for a much longer period. Of course, when you buy a car, bulldozer, trawler or computer, we do not know how long you think each and every one. The best we can do in the beginning is to guess how long it will be productive for you. Auditors & # 39; The attitude is that educated guess is better than nothing at all.
We could assume that the construction will be 50 years so that we will transfer 2% of the balance sheet balance to the profit and loss account each year. After 50 years, we have transferred all the costs and we have a book value of $ 0.00.
We can assume that your office furniture has 10 years, so we will transfer 10% of the cost of the balance sheet to the income statement each year. After 10 years, we've transferred all the costs and we have a book value of $ 0.00.
Depreciation is the cost of property, spread over its useful life. The amount we transfer from your balance sheet to your financial statements is what we call depreciation.
So now you can quote the booklet on a depreciation, you can not! It is the cost of an asset, scattered over its useful life. Talk like this and people will think you're an accountant!
I will facilitate the numbers:
You buy your car for $ 30,000. You estimate it will last 5 years, so we lower it at $ 6,000 a year – one fifth a year.
After year one, her book value is $ 24,000 (cost $ 30,000 – $ 6,000 depreciation)
After two years, her book value is $ 18,000 (at last book value $ 24,000 – $ 6,000 depreciation)
a year, 6,000 dollars go out of your balance sheet and in the income statement, and as it costs it reduces your profit by $ 6,000.  Profit and cash flow are not necessarily the same
The above explains why you can have high profits and falling bank accounts … or a lot of losses and rising bank accounts … or both profits and banking go up or both go down.
There is no connection between profit and bank balance (or cash flow) – depreciation is one of many reasons. Depreciation is simply a book transaction – it is only transferring between the accounting authorities.
So in the first year, your bank account went down to the cost of the car ($ 30,000) and your profits went down only with the cost of $ 6,000.
In the second year, the car had no impact on your bank account, but you made another $ 6,000 (depreciation) of your profits. And the same in the next three years.
The same is true when you're preparing your budget – budget depreciation is in line with your budget, but not in budget funds.
Buying a Business and Making Intelligent Investment Decisions
The above may seem like an intellectual e output that has no special connection to your reality … to anyone and # 39; s real life, really!
But what you've learned here (or somewhere else) is that the book value that assets are shown in the balance sheet are not significant for the value of these assets. Book products are simply the mathematical balance of the remaining after a few depreciations have been taken. And since depreciation is the best guess in the first place, should not rely on asset prices.
If you invest in a business, do not trust the assets and # 39; book value for anything. The book value means nothing to you. If you do not know what they are worth, do not look at the accounts, but get a valuation to evaluate the assets for you.
What I've Left
Depreciation is a big topic and my goal has been to explain its main features.
- Why do not we rate most assets the same amount (eg $ 6,000) each year,
- What you (or your accountant) do when you sell a property you have written off and
- Taxpayers many rules for depreciation.
If you have any questions about depreciation, call me.
* Every so often, the people who govern the auditors come out with different names for the same old things. I never hope it's confusing people, but I've noticed that every new name of the old is gradually bigger and bigger each time.
What we used to call Revenue Summary is now required to call Financial Performance Statement . What we used to call Balance Sheet must now call Statement of Financial Statements . Anyway, I think it will keep someone happily working!