In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in a systematic manner until the value of the asset becomes zero or negligible. The fixed assets include the following: buildings, furniture, office equipment, machinery and many more. A land is the only exception which cannot be depreciated as the value of land appreciates with time.
Different methods of depreciation are available to allow business owners to depreciate their assets earlier; accelerated depreciation rules are often put into place by our elected officials in order to “encourage” business owners to spend money on equipment which in turn increases spending.
Below are the advantages of depreciation for your properties – commercial or personal use:
Produces a matching expense
One major advantage of depreciation expense is that it helps companies fairly state the amount of expense incurred as a result of using an asset during an accounting period to properly match with the revenue that the asset use intends to generate in the same period. Without appropriately charging an asset’s purchase cost to depreciation expense, companies may understate or overstate total expenses and thus misstate revenues, reporting misleading financial information.
Determines the proper value of assets
Using depreciation expense also helps companies correctly report assets at their net book value. At first, companies are recording fixed assets at their original purchase costs. However, asset value decline over time as the result of asset uses that likely cause an asset’s wear and tear. In result, the companies must adjust an asset’s value to its net remaining value. An asset’s net book value is the original purchase cost subtracted by the asset’s accumulated depreciation, the total depreciation expense from all previous periods.
Aids in recovering asset costs
Depreciation expense provides a way for recovering the purchase cost of an asset. Unlike asset expensing, using asset depreciation helps companies to recover total asset cost over the useful life of the asset through periodic depreciation expense. Depreciation expense is a non-cash charge against revenue, which allows companies to set aside part of the revenue as funds for future asset replacement. Without charges of depreciation expense, the portion of revenue might have been inappropriately used for other purposes.
Reduces the tax
Depreciation expense helps companies generate tax savings. Tax rules allow depreciation expense be used as tax deduction against revenue in arriving at taxable income. The higher the depreciation expense, the lower the taxable income, allowing more tax savings. In fact, sometimes companies use accelerated depreciation to charge higher depreciation expense in certain periods when they expect to have higher revenue to purposely lower taxable income and achieve tax saving.
A good time for rebuying
A lot of investors view the excess amount of depreciation as a sign that the executive border is not reinvesting the money in the operation. So, for big companies and people that want to sell their business, the depreciation in the books helps to see which time is best to reinvest in assets.
Makes the revenue looks greater
While the business will actually have to pay for the asset in some way, recording a large expense on the books will make its revenue stream appear much lower to outside observers. By using depreciation, businesses can make their revenue seem greater.