Some advice please.

[japzuki]

Hi everyone,

I am really new to accounting so if any of the following makes no sense at all I must apologize in advance. Ok, So we are opening a business in a country where the tax laws are, shall we say of no real importance. So I am wondering if I still need to keep track of depreciation as I will not be filing tax returns or benefiting from a favourable tax rate to cover depreciation expenses?

I don't completely understand depreciation but I will explain a little about our project and maybe you can advise me a little. The total initial investment in buildings is $600,000 using straight line depreciation with a usable life of 25 years I make that depreciation rate of $24,000 a year.

So if I was recording this for tax purposes would how would I need to record this? something like this?
Fixed asset buildings- $600,000
Annual depreciation expense - $24,000
Net asset buildings value - $576,000

What I don't really understand is where does that $24,000 expense go because wouldn't that expense would come from the company's operating profits?? the $600,000 is the initial investment so does it go back to repaying the investment? or does it just stay in the bank until its needed for the replacement or repair of the buildings etc..? Or am I completely misunderstanding the concept? because I have also noticed an accumulated depreciation account is this what i should use instead of the expense account as it keeps the cash value as a constant?.

Fixed asset buildings- $600,000
Accumulated depreciation - $24,000
Net asset buildings value - $576,000
Total asset value - $600,000


So if depreciation is just used for tax purposes would it be a good idea to create an account and annually put a percentage of the company profits to cover future building repairs etc...

I am sorry if my explanation is a bit all over the place as I said I am new to all this. I thanks you in advance for any advice.

Regards,

Japz

 

[geekgirl]

The main reason why we depreciate fixed assets is due to the matching principle. We match expenses to periods where those expenses earned revenue. We spread the cost of the fixed asset ($600,000) into its useful life (25 years) and deduct this depreciation expense($24,000) to determine book income. We use MACRS depreciation schedule to determine taxable income.

 

[ALSG]

when you depreciate your asset the value decreases... tax computation you have to add back depreciation because its disallowed item.. but you have something called capital allowance which you can use to deduct your chargeable income

 

[japzuki]

thanks fr your replies.

But I still don't understand where the depreciation expense goes?? The $24,000 will come out of my profits on the profit and loss statement and debit my depreciation expense account. However I have already paid out the initial investment (600,000) for the construction of the buildings.So do I physically take that $24,000 out of the business as a repayment for the $600,000 that i have invested? or does it stay sloshing around in business until its needed for the repair or the replacement of the buildings???

Just to repeat I am in a country where I don't need to pay any business/income taxes. So I purely need to understand this to get a realistic understanding of how the business is functioning.

Thanks

 

[Triest123]

thanks fr your replies.

But I still don't understand where the depreciation expense goes?? The $24,000 will come out of my profits on the profit and loss statement and debit my depreciation expense account. However I have already paid out the initial investment (600,000) for the construction of the buildings.So do I physically take that $24,000 out of the business as a repayment for the $600,000 that i have invested? or does it stay sloshing around in business until its needed for the repair or the replacement of the buildings???

Just to repeat I am in a country where I don't need to pay any business/income taxes. So I purely need to understand this to get a realistic understanding of how the business is functioning.

Thanks

=> In other aspects, depreciation can be viewed as a sinking fund to ensure
the company can retain sufficent cash to buy a new asset to replace the old one.

The profit earned by the company can be fully distributed to the owner.
If the depreciaton is provided, the profit earned by the company will be reduced.
The company's cash (i.e. the profit) distributed to the owner will also reduced.
In other words, the company can retain the cash to buy a new fixed assets to
replace old one.

e.g.
Sevice Income : $100,000
Less : Depreciation $20,000
Profit $80,000

The profit (i.e. the cash) distributed to the owner is only $80,000.
The company now retain $20,000 cash acting as reserves for
replacing the old asset

 

[japzuki]

=> In other aspects, depreciation can be viewed as a sinking fund to ensure
the company can retain sufficent cash to buy a new asset to replace the old one.

The profit earned by the company can be fully distributed to the owner.
If the depreciaton is provided, the profit earned by the company will be reduced.
The company's cash (i.e. the profit) distributed to the owner will also reduced.
In other words, the company can retain the cash to buy a new fixed assets to
replace old one.

e.g.
Sevice Income : $100,000
Less : Depreciation $20,000
Profit $80,000

The profit (i.e. the cash) distributed to the owner is only $80,000.
The company now retain $20,000 cash acting as reserves for
replacing the old asset

Thanks you so much for your clear and direct answer to my question. This is what I originally thought it was for, a kind of insurance fund to replace the asset when needed and for tax purposes it just reduces the income that you have to declare therefore leading to a lower tax on your income.

One more thing if you have time. When I close this accumulated depreciation account at the end of the accounting period where would this balance go? Would it go to another account lets say "Asset purchase" or something like this? Ready to be used for any necessary purchases/ replacements in the next accounting period?

Thank you soo much again.

 

[Triest123]

Thanks you so much for your clear and direct answer to my question. This is what I originally thought it was for, a kind of insurance fund to replace the asset when needed and for tax purposes it just reduces the income that you have to declare therefore leading to a lower tax on your income.

One more thing if you have time. When I close this accumulated depreciation account at the end of the accounting period where would this balance go? Would it go to another account lets say "Asset purchase" or something like this? Ready to be used for any necessary purchases/ replacements in the next accounting period?

Thank you soo much again.

=> The accumulated depreciation account would not be closed. It aims to reduce the
asset's value. (i.e. what so-called the net book value (or the carrying amount) of the
asset as shown on the balance sheet).

The carrying amount of an asset = The costs of acquiring an asset - its accumulated depreciation)