How to Determine Whether to Depreciate an Asset
There are a lot of unique aspects to being a business owner. One of the main differentiators is how much equipment, tools, and supplies go into your everyday work. The downside is that these items can sometimes make accounting more challenging, such as deciding whether to depreciate an asset.
- What do you expense?
- What do you send to cost of goods sold?
- What is an asset, and should it be depreciated?
These are all excellent questions, but in this article, we are going to discuss ways artists can determine whether they should depreciate an asset.
What is Depreciation?
Simply put, depreciation is how accountants record the decrease in the value of an asset.
For example, say you buy a brand new computer and it costs you $3,000. Let’s also say this computer has an average lifespan of 5 years. In accounting, we would record your computer as a $3,000 asset. Then decrease the value of the asset by $600 every year.
Please note, this is a very basic example. Similar situations can get complicated if you sell the computer 5 years later or if the computer completely breaks in year 4. This is why it is always good to work with a bookkeeper if you are handling some of these more complicated items.
What Must a Depreciable Asset Have?
For an asset to be depreciable, it must have 3 things.
- You must be the owner of the asset. If you are renting a room or piece of equipment, this will be expensed. You did not pay for the entire value of the asset, so you cannot depreciate it. Instead, you are making monthly payments and those will be expensed.
- It is primarily used in your business. If you are looking to depreciate a personal asset, it cannot be included in your business financial statements. Depreciated items must be used to generate income for your business.
- It has a lifespan of at least a year. Assets that have a lifespan of a year or longer are considered long-term. Anything shorter should be expensed.
When Do You Depreciate an Asset?
Not all tangible assets are depreciated. Some items should be expensed or sent to COGS because they have a shorter lifespan, are inexpensive, or they go into the products you are selling. This means they sit on your income statement for a period and then are forgotten.
Whereas, assets that can carry value for a long period of time, will remain on the balance sheet until they are fully depreciated.
Examples
Example 1: A Vehicle
If you purchased a vehicle for the sole purpose of your business, this could be a depreciable asset. However, if you are simply using your personal vehicle to drive to trade shows or customer sites, then this is not depreciable.
Any items that are purchased for personal use cannot be depreciated in your business’s financial statements.
Instead, you will want to record your expenses and mileage for driving to these work-related locations. Those may be deductible on your business tax return.
Example 2: Leased Office Space
Since you are leasing the office space and you do not have any ownership, you cannot depreciate it. You did not purchase the space in its entirety and are likely making monthly payments, which should be expensed.
Example 3: Equipment or Machinery
Equipment or machinery that is owned by the business and has a lifespan of at least a year can be depreciated. How you depreciate will be dependent on several factors that you should discuss with your bookkeeper.
If your business often works with big-ticket items, you will be using for years to come, it is worth your time to talk with a bookkeeper on how to properly depreciate these items. They must show up on your balance sheet, so you have an idea of what value is truly in your business.
Not sure if one of your assets should be depreciated? We offer free consultations to discuss the financials of your business and how we can help set you up for success. Contact us today!