Even though using bookkeeping software will help with the daily use of accounting functions for a small business, it’s still important to have an understanding of the basic functions of accounting. Before understanding depreciation entry methods, schedules and accruals it’s important to understand the functions of debits and credits. Understanding how debits and credits work is the first step into grasping the fundamentals of accounting.
What is Fixed Asset Depreciation?
Since most assets depreciate in value overtime, accounting practices mandate that fixed assets are prorated to decrease their value on the books over an estimated period of time. The predetermined prorate amount is treated as an expense. As the fixed asset value is decreased, the expense account is increased.
Methods of Fixed Asset Depreciation
There are many methods of fixed asset depreciation. The most common method of depreciation is the straight-line method. The straight-line depreciation method allows for equal deprecation over the life of the asset. Straight-line depreciation is also the easiest method of depreciation to calculate.
There are also various accelerated methods that allow for larger depreciation amounts in the early life of the asset. Accelerated methods are especially useful for income producing assets that produce more income during the early life of the asset. Some of the more common methods are sum-of-the years-digits and the double declining balance methods.
Fixed Asset Depreciation Schedule and Accrual
The actual amount to be depreciated is often called the depreciation schedule. The accrual amount is usually posted to the journal account at the end of each month. Since expense is increased, it’s posted as a debit and the asset (value) is decreased so it’s posted as a credit. Whatever method of depreciation is used, the first thing to determine is the actual amount of depreciation and useful life of the asset.
- Determine the useful life of the asset in years
- Determine the salvage value of the asset after its useful life
- Deduct the salvage value from the purchase price of the asset to determine the amount to be depreciated over its life.
Since depreciation is treated as an expense, it lowers the net profit of the business. Since most small businesses are taxed on net profit, depreciation can help lower the tax burden. Accelerated methods will naturally realize a bigger tax benefit during the early life of the asset. Since there are certain rules governing depreciation it's best to consult a certified public accountant (CPA) or accounting professional before deciding on a depreciation method.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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