[Gnucash-changes] * David Harrison's updates to depreciation

Jon Lapham lapham at cvs.gnucash.org
Sun Oct 31 09:00:25 EST 2004


Log Message:
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 * David Harrison's updates to depreciation

Modified Files:
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    gnucash-docs/guide/C:
        ch_dep.xml

Revision Data
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Index: ch_dep.xml
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RCS file: /home/cvs/cvsroot/gnucash-docs/guide/C/ch_dep.xml,v
retrieving revision 1.2
retrieving revision 1.3
diff -Lguide/C/ch_dep.xml -Lguide/C/ch_dep.xml -u -r1.2 -r1.3
--- guide/C/ch_dep.xml
+++ guide/C/ch_dep.xml
@@ -12,37 +12,69 @@
 -->
  <chapter id="chapter11">
  <title>Depreciation</title>
- <para>
-This chapter will present some of the techniques used to keep track of the changing values of assets, IE: depreciation, unrealized gains, capital gains.   </para>
+ <para>This chapter will introduce the concept of depreciation in accounting and give some real life examples for using it.</para>
+
  <sect1 id="dep_concepts1">
  <title>Basic Concepts</title>
- <para>
-This chapter will present some of the techniques used to keep track of the changing values of assets, IE: depreciation, unrealized gains, capital gains.
-  </para>
- <para>
-Certain resellable assets can change value over time, such as stocks, bonds, houses, or cars.  Some assets (eg: a stock) could increase in value, some (eg: a car) could decrease in value.  It is important to be able to track some of these time-dependent asset valuations, this chapter will show you how.
-  </para>
-  <para>
-Probably everything you own will increase or decrease in value over time. So, the question is for which of these assets should you track this changing value?  The simple answer is that you only need to track this for items which could be sold for cash in the future or which relate to taxation.  
-  </para>
-  <para>
-Consumable and disposable items (eg: food, gas for your car, or printer paper) are obviously not involved.  Thus, even though the new clothes you recently bought will certainly depreciate, you would not want to track this depreciation since you have no intention of reselling the clothes and there is no tax implications to the depreciation on clothing.  So, for this example, the purchase of new clothes should be recorded as a pure expense... you spent the money, and it is gone.
-  </para>
- <para>
-Depreciation is the effect in which the value of an asset decreases with time.  The often used example of an asset to which this is often applied is an automobile.  An automobile holds retained value after the purchase date, but this value decreases with time.  If you hold assets for business purposes, their depreciation can be treated as a deduction for tax purposes.
- </para>
- <para>
-Depreciation is usually recognized as an ongoing (accrued) expense, gradually reducing the value of an asset toward zero. 
- </para>
- <para>
-Normally, depreciation is only calculated on assets used for professional or business purposes, because governments don't generally allow you to claim depreciation deductions on personal assets, and it's usually pointless to bother with the procedure if it's not deductible.  The only case where you may want to track depreciation for personal assets would be if you will sell the asset in the future and you want to track your potential personal worth.
- </para>
+ <para>Depreciation is the account method for expensing capital purchases over time.  There are two reasons that you may want to record depreciation; you are doing bookkeeping for your own personal finances and would like to keep track of your net worth, or you are doing bookkeeping for a small busines and need to produce a financial statement from which you will prepare your tax return.</para>
+
+  <para>The method of recording depreciation is the same in either case. but the end goal is different.  This section will discuss the differences between the two. But first, some terminology.</para>
+
+  <itemizedlist>
+  <listitem>
+  <para><emphasis>Net book value</emphasis> - this is the difference between the original cost and the depreciation taken to date.</para>
+  </listitem>
+  <listitem>
+  <para><emphasis>Salvage value</emphasis> - this is the value that you estimate the asset can be sold for at the end of it's useful life (to you).</para>
+  </listitem>
+  <listitem>
+  <para><emphasis>Book depreciation</emphasis> - this is the amount of depreciation that you record in GnuCash.</para>
+  </listitem>
+  <listitem>
+  <para><emphasis>Tax depreciation</emphasis> - this is the amount of depreciation that you take for income tax purposes.</para>
+  </listitem>
+  <listitem>
+  <para><emphasis>Original cost</emphasis> - this is the amount that the asset cost you to purchase.  It includes any cost to get the asset into a condition in which you can use it.  For example - shipping, installation costs, special training.</para>
+  </listitem>
+  <listitem>
+  <para><emphasis>Fair market value</emphasis> - the amount for which an asset could be sold at a given time.</para>
+  </listitem>
+  </itemizedlist>
+
+ <sect2 id="dep_concepts_personal2">
+ <title>Personal Finances</title>
+  <para>Depreciation is used in personal finances to periodically lower an asset's value to give you an accurate estimation of your current net worth.  For example, if you owned a car you could keep track of its current value by recording depreciation every year.  To accomplish this, you record the original purchase as an asset, and then record a depreciation expense each year (See section 11.4 for an example).  This would result in the net book value being approximately equal to the fair market value of the asset at the end of the year.</para>
+
+  <para>Depreciation for personal finance has no tax implications, it is simple used to help you estimate your net worth.  Because of this, there are no rules for how you estimate depreciation, use your best judgement.</para>
+
+  <para>For which assets should you estimate depreciation?  Since the idea of depreciation for personal finances is to give you an estimate of your personal net worth, you need only track depreciation on assets of notable worth that you could potentially sell, such as a car or boat.</para>
+
+  </sect2>
+
+ <sect2 id="dep_concepts_business2">
+ <title>Business</title>
+
+  <para>In a manner similar to personal finance, businesses use depreciation to estimate net worth, this is called book depreciation.  However, the businesses also report depreciation for tax purposes, and as such it is highly regulated by tax laws.  Tax depreciation does not necessarily involve assets which lose resale value.  This means that a business may have discrepencies between book and tax depreciation.</para>
+
+  <para>One of the basic concepts in accounting is the matching of revenues and expenses.  When you purchase a capital asset (e.g. car, computer, equipment), you will use this asset to earn income for a number of years.  Instead of expensing the cost of the asset in the year it was purchased, you expense a portion of the cost each year in a manner that matches flow of revenue.  This process is called depreciation.</para>
+
+  <para>Now, what purchases should be capitalized?   If you expect something that you purchase to help you earn income for more than just the current year, then it should be capitalized.  This includes things like land, buildings, equipment, automobiles, and computers - as long as they are used for business purposes. It does not include items that would be considered inventory.  So if you made a purchase with the intent to resell the item, it should not be capitalized. </para>
+
+  <para>In addition to the purchase of the asset itself, any costs associated with getting the asset into a condition so that you can use it should be capitalized.  For example, if you buy a peice of equipment and it needs to be shipped from out of town, and then some electrical work needs to be done so you can plug the machine in, and some specialized training is needed so you know how to use the machine, all these costs would be included in the cost of the equipment.</para>
+
+  <para>You also need to know the estimated salvage value of the asset.  Generally, this is assumed to be zero.  The idea behind knowing the salvage value is that the asset will be depreciated untill the net book value (cost less depreciation) equals the salvage value.  Then, when the asset is written off, you will not have a gain or loss resulting from the disposal of the asset.</para>
+
+  <para>The last step is to determine the method of depreciation that you want to use.  This will be discussed on the next few pages.</para>
+
  <note>
  <para>
 Warning: Be aware that different countries can have substantially different tax policies for depreciation; all that this document can really provide is some of the underlying ideas to help you apply your "favorite" tax/depreciation policies.  
  </para>
  </note>
- </sect1>
+
+  </sect2>
+  </sect1>
+
 
   <sect1 id="dep_value1">
  <title>Estimating Valuation</title>
@@ -63,11 +95,10 @@
   </itemizedlist>
   <sect2 id="dep_valueschemes2">
  <title>Depreciation Schemes</title>
-  <para>
-A <emphasis>depreciation scheme</emphasis> is a mathematical model of how an asset will lose value over time.  For every asset which undergoes depreciation, you will need to decide on a depreciation scheme.  Since depreciation of assets is very often driven by tax policies, the discussion of depreciation will focus in that direction, on some of the more common depreciation calculation schemes.    </para>
-  <para>
-Once you have an idea of the future value of your asset, you must decide on a depreciation scheme (remember, this may be dictated by your local tax codes).  This section will present 3 of the more popular depreciation schemes: <emphasis>linear</emphasis>, <emphasis>geometric</emphasis>, and <emphasis>sum of digits</emphasis>.
-  </para>
+  <para>A <emphasis>depreciation scheme</emphasis> is a mathematical model of how an asset will be expensed over time. For every asset which undergoes depreciation, you will need to decide on a depreciation scheme. An important point to keep in mind is that, for tax purposes, you will need to depreciate your assets at a certain rate.  This is called tax depreciation.  For financial statement purposes you are free to choose whatever method you want.  This is book depreciation.   Most small businesses use the same rate for tax and book depreciation.  This way there is less of a difference between your net income on the financial statements and your taxable income.</para>
+
+  <para>This section will present 3 of the more popular depreciation schemes: <emphasis>linear</emphasis>, <emphasis>geometric</emphasis>, and <emphasis>sum of digits</emphasis>.  To simplify the examples, we will assume the salvage value of the asset being depreciated is zero.  If you choose to use a salvage value, you would stop depreciating the asset once the net book value equals the salvage value.</para>
+
   <orderedlist>
   <listitem>
   <para>


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