Why some costs are not immediately deductible
Hello All,
Depreciation is one of those accounting terms that sounds like technical jargon, but is actually conceptually straightforward. It simply refers to the measure by which asset will lose value over time. For example when you buy a car (which are notorious for losing a significant amount of value as soon as you drive it off the car dealership parking lot), it will be worth less each year as it starts to deteriorate. Finally, at some point in the future you will have to replace it.
Depreciation is primarily a function of time and usage. From an accounting perspective, when you buy an asset you have to determine whether it has a useful life that extends beyond one or a few uses. Materials that you buy to make your product that you will then sell are used only once. A subscription that you pay for monthly for rent or software is only good for that month. Paper for your printer is used on an ongoing basis. (There are also some items that may have a useful life that extends beyond a year such as a pen or a bottle of glue, but because they are so small, there is very little value to tracking them.)
Depreciation comes into play when you have a larger value item, such as a computer, that will last several years. Consequently, from an accounting perspective, the expense of the computer is only accurately represented when it is spread out over the life of the computer. If you expensed it immediately, your expenses would be overstated in year 1 and understated in every subsequent year. This results in an inaccurate profit and loss statement and reduces the effectiveness of the analysis of your financial results.
From a tax perspective, Revenue Canada has created a moniker called capital cost allowance (CCA) to reflect depreciation. Since it would be extremely time consuming (and still inaccurate) to try and come up with an estimated useful life of each individual asset, they have established a series of classes that has a rate of depreciation. Computers go into Class 50 with a rate of 55% of net depreciated amount (see my blog post for how this works). Furniture goes into Class 8 with a rate of 20%. And so on.
Since these assets, with a useful like exceeding one year cannot be expensed right away, they must be depreciated. By defining a class and a rate, it greatly simplifies the calculation and makes it less arbitrary.
So, as a business owner it is important to evaluate the items that you purchase for your business, determine if they have a useful life that exceeds one year. If so, they should be recorded as fixed assets in your accounting and tax return and depreciated appropriately.
Blog Post
A post about the difference between depreciation and CCA and how it applies to your business
What is Capital Cost Allowance and How Does it Impact Your Business
Frequently a client of mine will purchase a high ticket item such as a computer or a piece of furniture and will simply show it as an expense on their profit and loss. As far as they are concerned,
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QuickBooks Tip: Recording Capital Assets
A depreciable asset should be reflected under property, plant and equipment (PPE) on your balance sheet. If you don’t have an account, you would create a new account, choose the appropriate type in QBO and then allocate your assets to this account (you can claim any sales taxes paid in the normal way). You also have to create an account for accumulated depreciation on the balance sheet under PPE and a corresponding depreciation expense account. When you calculate your depreciation (usually on an annual basis for small business), you would debit depreciation expense and credit accumulated deprecation. It is ok to use the same depreciation amount that is reflected on your tax return, assuming that this approximates the actual depreciation of the asset.
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Small Business Tax Facts(Sole Proprietorships/Registered Businesses/Self Employed Workers)
This book helps you take control of your finances by giving you a better understanding of tax (brackets, tax rates, deductions etc), how it applies to your unincorporated small businesses and how to do your own tax return (or at least understand what your accountant does). It also includes a comprehensive breakdown of deductible expenses, by category with special sections on more complex deductions such as home office, vehicle and capital cost allowance.
FastStart Your Corporation(Corporations)
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FastStart Your Business (Sole Proprietorships)
A step by step guide for anyone who is planning to start a Canadian business or become self employed (and does not want to incorporate) and wants to know what they need to do or simply has questions.
Small Business and Your Dividends (Corporations)
For incorporated small business owners who want to know more about small business dividends, the differences between salary vs dividends and which is better and step by step instructions on how to file your own dividend declarations (T5s).
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Wishing everyone a bearably hot weekend!
Ronika
