How to account for depreciation on the books

Introduction

Depreciation is the natural reduction in value of any of your company's fixed assets. For example, your vehicles and your computers are worth less every year, or they depreciate every year. If you are in charge of bookkeeping, you will need to account for that depreciation. The reason you need to account for it is that if you enter in $20,000 on an asset sheet for a new vehicle, the amount that the vehicle is actually worth will change every year. If you don't account for depreciation, in ten years, that vehicle will still look like $20,000 asset on your books. If the vehicle is only worth $2000 by that time, it is misleading and wrong to have the car listed as a $20,000 asset.

Instructions

Difficulty: medium easy

Steps

Step 1: Set up a depreciation account. Using a double-entry account, set up a depreciation account with depreciation registered on the debit side and accumulated amortization registered on the credit side. You should make a separate entry for every type of item that might depreciate. For example, in the account column, you might have an entry for Computer Depreciation and an entry for Accumulated Amortization, Computers. Once the registry is set up, use it just as you would any other double entry account. That is, make an entry for both the debit and the credit at the end of the year.

Step 2: Estimate the depreciation. As far as the IRS is concerned, there is really only one way to estimate your loss; this is called the modified accelerated cost recovery system or MACRS. This system uses a linear equation to estimate the value of your property. The way it works is to draw a line from two points on a graph with the amount the item is worth on one axis and years of service on the other. One end point is the price that you paid for the item when it was new-this sits at 0 years of service. The other endpoint of the line is at 0 dollars of value and the number of years that the item is expected to be valuable. From the line between the two points, the estimated value of the item can be predicted for each year of service.

Unless you really like statistics and handling lots of numbers, you might try out a computer program to track the depreciation of your assets. A computer program can save you time. What's more, fixed asset programs also proved guidelines for tax rules. These programs calculate depreciation for "alternative minimum tax". This will help you make up for depreciation by minimizing the assets that you have to report to the IRS.

There are other acceptable ways to estimate depreciation, on is to estimate the percentage that an item will depreciate over a year of use. For example, a computer might depreciate by about 30% per year.

Step 3: Balance your books. At the end of the year when it is time to get things ready for the IRS you can add the debit column and subtract that number from the original price of the asset. If you sell the item, make an entry with an account heading of "Disposal" and balance the entry. On the debit side include Bank Account (the price you got for selling the item), Accumulated Amortization (the total amount the item depreciated while you had it), and Depreciation (this is the residual value between the original price of the item when the sale price and the accumulated amortization price are subtracted). On the credit side, include the original price of the item.

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Categories: Depreciation,

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