Every company has fixed assets, you’re probably reading this on one right now. Fixed assets are purchases your company makes that add value to the business. The best examples are computers, office furniture and company cars. Instead of expensing these items as the are purchased, these assets are expensed over a period of time in the form of depreciation.
When calculating depreciation there are a few main considerations:
- Depreciation method – Straight-line (evenly over the useful life) vs. accelerated depreciation (double the rate, early in the life of the asset). The benefits of each are: straight-line is the easiest to calculate and accelerated provides a reduction in net income in early life, which is beneficial for tax purposes.
- Useful life – Each asset class has a different useful life. The most common classes we see are 5 years (computers) or 7 years (office furniture).
- Salvage value – What you can sell your asset for at the end of it’s useful life. Your basis for depreciation will be original cost – salvage value.
The basic journal entries you will make are:
Purchase of laptop for $1000:
DR Asset – Computers $1000
CR Cash $1000
Monthly depreciation (5 year, straight-line: $1000/60 months):
DR Depreciation expense $16.7
CR Accumulated Depreciation $16.7
It is important to note that the accumulated depreciation is a contra account on the balance sheet that in effect reduces the original cost of the asset.
Other items of note:
Depreciation is a non-cash entry for your company, meaning no cash is going out of your bank account for this expense item. This becomes a factor in your statement of cashflows and for tax purposes.
Next up in our educational series will be Revenue Recognition!