How to Account for Different Asset Types

Accounting for the purchase of major assets can be confusing to many business owners. The trouble arises when the purchase of assets – such as equipment, buildings and other property – is treated as if it were an ordinary expense. In fact, these major purchases should be addressed quite differently; unlike regular expenses, they have long life-spans, and this kind of a purchase should be accounted for by deducting the cost over the item’s useful life as a depreciation expense.

Buildings and land

The most obvious asset categories are buildings and land. Note that these are treated as separate categories because land is considered as distinct from the building that sits on it. The cost of land is never written off as an expense. By contrast, the cost of a building is deducted over time.

Since buildings and land are commonly purchased together, the owner must apportion a separate amount for the land and depreciate the building cost over several years. The acquirer’s cost includes financed amounts, and closing costs are counted as part of the purchase price. Newly constructed business buildings should include depreciable costs for architect fees and land clearing.

Upgrading a property

Adding or replacing some of the structural components of a building increases its life-span, so these costs will also be depreciated rather than expensed immediately. These changes may include upgrades to such important elements as the building’s roof, plumbing system, interior walls or exterior facade.

If you’re making additions or changes to the structure of a building that you’ve leased from someone else, these “leasehold improvements” are also considered assets.

Business equipment

Various types of equipment are purchased for use in business. Distinctive depreciation periods are assigned to machinery, vehicles, computers, software, and other asset types. Small items – such as staplers and disk drives – are expensed immediately rather than depreciated, due to their minimal cost.

Depreciation

The key ingredients involved in accurately calculating depreciation include historical cost, in-service date and property description. Costs for business assets are depreciated over defined periods that depend upon the type of asset. Changes in tax laws occasionally alter these depreciation periods, but the law in effect when an asset is placed in service applies for as long as that property is deployed in the business.

The in-service date is the date that the asset is first used for business purposes. For instance, the costs of a company’s new head office are not depreciated until the enterprise occupies the structure.

Asset value, as it is recorded on small business financial statements, is not adjusted for fluctuation in market value. Rather, the historical cost remains on the organization’s books along with accumulated depreciation.

This historical-cost method is primarily practiced in the U.S., where depreciation is a tax requirement in addition to being an accounting standard. Large companies outside the U.S. may use international financial reporting standards that account for changes in asset market values.

The historical-cost method has the advantage of averting market value assessments, which are typically impractical for small operations.

It’s Time to Evaluate and Improve Your Accounting Software

The expression “garbage in, garbage out” might have been coined for business owners who don’t know how to organize their accounting records and wind up with a mess.

In other words, don’t blame your bookkeeper if your sloppy records cost you time and trouble. Accounting software, such as QuickBooks, can be a wonderful tool if the data is organized effectively. And that is a job that you, as the owner of your business, need to control.

Now that tax preparation is over, you may need to consider how your accounting records can be improved, so that next year’s tax reporting is simpler and less costly.

Programs like QuickBooks will accept information even if it’s not set up properly. Examine the categories that have been selected for each account; these reflect how the accounts appear on your financial statements.

Personal expenditures or those the business can’t use as tax deductions should never appear with your business expenses on the Income Statement. Asset purchases should be accounted for on the Balance Sheet.

You also should record loan payments by separating interest expenses from the principal. Ensure you have a liability account for applying payments of loan principal, and record a journal entry for prior year depreciation of assets.

Unless you address these and other factors now, your accounting records will become a useless mess. Discuss the details with your accountant, and work with your bookkeeper to ensure the software is set up correctly from the get go. No more “garbage in, garbage out.”