Understanding How Asset Depreciation Works for Businesses

In business, one of the most common terms you’ll hear is the term “assets” and “depreciation.” Both concepts are important for eCommerce accountants, business owners, financial consultants, and industry experts as they directly impact the tangible assets of a particular business. The following guide explores the importance of depreciation and how businesses should deal with it.


Tangible and Intangible Assets Explained


Any business or corporation deals with two main types of assets, which are crucial to the organization. These two types are:


  • Tangible Assets are physical “things” that your business owns. They come in the form of stock and inventory, your office building, furniture, equipment, vehicles, and machinery.

  • Intangible Assets are things that your business owns that don't have a physical form. A good example of intangible assets is trademarks, branding, copyrights, and patents associated with your business.


Looking at both types of assets, they have a significant difference. Tangible assets tend to lose value and depreciate over time, while intangible assets do not. This is where the concept of depreciation comes into play.


What is Depreciation?


Depreciation is defined as the expensing of an asset involved in producing revenues throughout its useful life. For accounting purposes, this depreciation refers to the allocation of the cost of assets to periods in which the assets are used. In a way, it affects the values of your business since the depreciation disclosed for each asset will reduce its book value on your balance sheet.


How Do Depreciable Business Assets Work?


You begin depreciating an asset when you start using it, or it is placed into service. The asset itself doesn’t have to be in us, but it can’t be sitting in an unopened box either. For example, you have a new computer for your office. Once you’ve set it up and turned it on, the asset is already placed into service. It doesn’t matter if you use it regularly or only on rare occasions. The asset will still depreciate.


Depreciation as an Accounting Transaction


Basically, depreciation is considered an accounting transaction. While an asset is being used, an accounting transaction takes place in which a certain amount of the cost of the asset is put into a depreciation expense account, and the initial cost of the asset is reduced by the same amount. Let’s jump to the end of the year, where the accumulated depreciation is shown on your business financial statements, along with the initial cost of all the property being depreciated.


This goes on until the asset finally stops depreciating, and that can happen when either one of the following events occurs:


  • Selling the asset

  • The asset has reached the end of its useful life


Are There Assets That Can’t Be Depreciated?


Not all assets can be depreciated because of their very nature. For example, a piece of land can’t really depreciate because it is never “used up”, and over time, it doesn’t actually lose value. In fact, it only gains more value as time passes. While buildings erected on a piece of land are able to depreciate, the land itself does not depreciate.


Current assets, which are assets purchased and disposed of within the same year, also don’t depreciate. This includes certain supplies, prepaid insurance, and accounts receivable.


Conclusion


Knowing how assets depreciate is important for any business owner. If you’re planning on buying assets for your business, you should be able to know what that asset’s value will become in time, so you know exactly where you’re putting your money.


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