Appreciation and depreciation are fundamental principles to understand for any small business owner. Appreciation logs any increase in the value of your assets over time, while depreciation logs any decrease in the value of your assets over time.
There are different ways to record both of these, so let’s explore exactly how they can factor into the accounting process for your small business!
Before you read further, here’s a quick refresher on what an accounting transaction is.
What Are The Causes Of Appreciation And Depreciation?
Appreciation refers to any increase in the value of the assets on a balance sheet, and is often used to measure increases in the value of real estate, stocks, bonds, or collectible items, amongst many other asset classes. These increases in value can be driven by a variety of factors: changing supply and demand dynamics, inflation, macroeconomic policy, or network effects. These factors often work in harmony to drive appreciating values across all types of asset classes.
On the other hand, depreciation refers to the opposite of the above scenario- any decrease in an asset’s value, driven by the same factor inputs, but flipped. Think: a reduction in demand, or a decrease in lifespan of your asset. We hate to break it to you, but as a small business owner, you’re more likely going to face depreciation vs appreciation throughout the accounting cycle.
Ultimately, the nature of the assets that you own dictates how often you’ll have to deal with these topics. Short-term assets like stocks can fluctuate on a daily basis, while daily fluctuations in long-term assets like real estate are less common. But it’s important to keep an eye on both, so that you can maintain a healthy balance sheet and keep an eye on your future cash flows!
How is Depreciation Calculated?
There are two fundamental concepts behind all depreciation calculations. First is the expected useful lifetime of the asset, which is exactly what it sounds like – how long the asset will be useful to your business for! Second is the salvage value of the asset, which is the amount that you’ll be able to re-sell that asset for at the end of it’s useful lifetime. With these concepts in mind, let’s explore the two basic formulas used to calculate depreciation.
The straight-line basis is the simplest way to calculate depreciation and amortization. You’ll begin by calculating the difference between the cost of your asset and its salvage value, and dividing that figure by the number of years it will last. See the formula below:
- Depreciation expense = (cost of asset – salvage value) / asset’s number of useful life years
The second formula is the declining-balance method. This is an accelerated method of depreciation that is used to record larger depreciation expenses at the beginning of your asset’s life, and smaller expenses at the end of that asset’s life. You’ll begin by calculating the current book value of your asset and deducting the accumulated depreciation from your cost basis. This method is generally useful for logging changes in the value of equipment that loses value quickly. See the formula below:
- DBD = current book value x depreciation rate (%)
Most small business accounting software will employ the straight-line depreciation method. But this isn’t to say that small business owners won’t need to use accelerated depreciation methods. Particularly those who have capital-rich assets (think: a photographer with expensive computers, lighting, sound equipment0. But in any event, most small business accounting will employ the use of these methods at some point in the accounting cycle. So trust in the best small business accounting software to navigate this with ease.
Appreciation, Depreciation, and Your Financial Statements
Generally speaking, the detailed calculations of the appreciation and depreciation of your company’s assets will not be listed on your financial statements (i.e., your income statement, balance sheet, or cash flow statement). However, it’s important for any small business owner to have a strong grasp of the value of their assets, and understand how they are changing in value over time. You never know when these details will factor into major business decision down the line.
It’s also important to note that exactly how you record the appreciation and depreciation of your company’s assets will ultimately impact your net income. And you never know when investors, or other interested third-parties, will want to access your financial statements. So chalk up another win for easy-to-use, streamlined small business accounting software that makes this otherwise daunting process a relative breeze!
Have questions about recording appreciation and depreciation of your company’s assets in Kashoo? Reach out to us anytime at firstname.lastname@example.org. We’re here to help!