Concepts guide - Depreciation

[David Harrison]

On Fri, 29 Oct 2004 18:30:46 -0300, Jon Lapham <lapham at jandr.org> wrote:

> 
> Well, I think it is better to be accurate/complex than simple/wrong.
> So, I changed the definition to your "...expensing capital purchases
> over time...".

Just nit-picking, but shouldn't it be "Depreciation is the accounting
method..." not "account method".

> 
> >>3) The list of terminology is great!
> >
> > Thanks
> 
> Oh, I forgot to ask before.  The definition of "Book depreciation"
> should mention something about accurately reflecting resale value?  (as
> opposed to "tax depreciation") Or is that not true?
> 

No, book depreciation has nothing to do with resale value.  Let me try
an example.

You purchase a computer for $1000.00.  Estimated useful life 5 years
with no salvage value.  For financial statement purposes you decide on
straight line depreciation.  The "book depreciation" is then is
$200.00 per year.

After the first year, the net book value of the computer is ($1000 -
$200) $800.  After the second year, $600 , and so on.  At no time does
this reflect the resale value.

Now, say you decide that after year two to sell the computer to a
friend for $550.  This results in a loss on disposal of capital assets
of  $50.  This results from the $600 book value from above less the
$550 proceeds of sale.

Let's look at that same sale from a tax perspective using my Canadian
laws.  The Undepreciated Capital Cost (equivalent to Net Book Value,
just different terminology) would be $504 (Trust me on this number). 
For tax purposes we have recapture of Capital Cost Allowance
(equivalent to depreciation, but again different terminology) of $56. 
This would be treated as income.

So on the books you have a loss of $50, but for tax purposes you have
income of $56. And this is only a simple example!!

> > 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.
> 
> All right, I re-wrote the openning paragraph.  Let me know what you think.

Try this:

"As opposed to personal finance where the goal is tracking personal
worth, business is concerned with matching the expense of purchasing
capital assets with the revenue generated by them.  This is done
through book depreciation.  Businesses must also be concerned with
local tax laws covering depreciation of assets.  This is known as tax
depreciation.  The business is free to choose whatever scheme it wants
to record book depreciation, but the scheme used for tax depreciation
is fixed.  More often than not this results in differences between
book and tax depreciation, but steps can be taken to reduce these
differences."

If you use this, then I would get rid of the second paragraph in that
section as it is somewhat redundant.  The "steps that can be taken..."
sentence may need further explaining, but I did touch on that in the
last sentence in the first paragraph in the Depreciation Schemes
section on http://www.gnucash.org/docs/v1.8/C/gnucash-guide/dep_value1.html.
 Basically, the step is to choose the same methods for book and tax
depreciation.