Concepts guide - Depreciation

[David Harrison]

On Fri, 29 Oct 2004 09:59:29 -0300, Jon Lapham <lapham at jandr.org> wrote:
> David, good stuff.
> 
> I updated the web pages with the new text, plus some modifications I
> made, take a look and let me know what you think.  You may need to
> reload the pages to clear you cache to see the changes (I had to do this
> anyway).
> 
> Basic Concepts:
> http://www.gnucash.org/docs/v1.8/C/gnucash-guide/dep_concepts1.html
> 
> 1) I added the first sentence definition "Depreciation is the account
> method for tracking the decreasing value of an asset over time."  I know
> that you do not like the "decreasing value" part of that definition, so
> please suggest something else.  But, I think it is important that the
> first sentence define in some way what we are talking about.  Remember,
> this will be the first time many people read about this topic.

The way that we have made the distinction between personal and
business makes this a difficult definition.  On the personal side,
your definition is correct. On the business side it's not.

So, on the business side, it's not so much that *I* don't like the
"decreasing value" part, it's just that that's not the reason for
depreciation.  If you were to buy a house as rental property, you
would record depreciation on the house.  This would cause the net book
value of the asset to go down.  However, in real terms the value of
the house is going up (hopefully).

So a better definition would be "depreciation is the process of
expensing capital purchases over time" or "the matching the expense of
a capital purchase to the revenue generated by that asset".  My
problem is wording it in such a way that the person reading it for the
first time would understand it.  I look at the definition I just
wrote, and I'm not sure if it's understandable enough for our reader. 
What do you think?

> 
> 2) I think we should pull the first two "reasons for depreciation" into
> the paragraph, rather than having them as bulleted list.  Agree?

Sure.

> 
> 3) The list of terminology is great!

Thanks

> 
> 4) Do you think it is necessary to have the last paragraph for the
> Personal Finances section that discusses estimating capital gains?
> There is another chapter that talks about the subject... maybe we should
> add a link to that chapter?

You're right.  I think a link to the unrealized gains section would be
appropriate.

> 
> 5) Business section.  I changed your "small business" to "business".  Is
> that okay?

Absolutely.

> 
> 6) I added the opening paragraph "Whereas in the personal finance world
> depreciation is used to estimate net worth, in the business world
> depreciation is used as a mechanism for receiving a tax deduction. As
> such, it is highly regulated by tax laws."  I'm not sure this is the
> best openning paragraph, but I think we need something that summarizes
> the differences between personal finance and business finance.

You're right, a summary is necessary.  In the business world, though,
you are free to choose whatever depreciation scheme you want for your
financial statements.  However, for tax purposes, the method is set. 
What this leads to is a difference between net income on the financial
statements and taxable income.  This isn't a problem, it's actually
the norm.  In fact, at least here in Canada (and probably every
country), there is a schedule on the corporate tax return that
reconciles the difference.  On the personal tax return (for businesses
that aren't incorporated) there is no such schedule, but the
depreciation is calculated on it's own schedule and subtracted from
your business income schedule after net income - in other words you
don't enter on the tax return the depreciation that you entered into
GNU Cash anyway.

Having said all that, the best (read easiest) way to determine what
depreciation scheme to use is to follow the tax law.  This minimizes
(not eliminate) the differences between financial statement income and
taxable income.

> 
> 7) I kept the "note" which mentions the tax law differences between
> countries.  Okay?

Yes, this absolutely needs to be in there!

> 
> http://www.gnucash.org/docs/v1.8/C/gnucash-guide/dep_value1.html
> 
> 8) For the estimating depreciation, I was not sure if you wanted to
> remove the section at the beginning that starts with "A central issue
> ...".  I think it is important that we mention some places you can go to
> to get estimations of valuation (blue book for cars, tax laws).
> 

I had intended to remove it.  I'll work these issues into the other
sections.  The blue book value belongs in the "personal" section,
while the tax law part belongs in the "business" section.


Overall, I *do* like the changes you made.  I'll do a little more
tweaking, but I think it's almost there!!

David