Often times small business owners ask me, do I really need to depreciate anything? What is an asset? I thought they were only used for big corporation I just work out of home do I have any assets? Simply put an asset is anything you or your company owns that is worth money. So it is the cash you have in your bank account to the buildings your company owns should you happen to be so lucky.
What confuses a lot of first time business owners that tackle their own bookkeeping whether they use a software or do it with the pen and paper method is how to categorize what they buy, what is a straight expense and what can be categorized as an asset?
Unfortunately there is no straight answer to this question, for some people an asset is going to be something that cost 400 dollars while for others an asset is going to be a car or a truck. As a rule of thumb an asset is something that will remain in your business for quite a while and has some sort of resale value. So the obvious ones are computers, cars, tools, equipment etc,
The difference between an asset and an expense and how it affects your account is as follows.
If you buy a lot of Ink Cartridges, paper, pens and other miscellaneous from your local staples for a total of 350 dollars you will expense that 350 dollars the day you made your purchase. That amount will be deducted from your income right away and will count towards the current period. In turn you will have to pay less income tax for the current period.
If however you buy a 600 dollars computer and classify it as an asset, nothing gets deducted of your net income. And your computer will go in the books as an asset worth 600 dollars. As time goes by your computer will be worth less and less, that is what depreciation is the value lost by your computer over time. So in this example we'll say that the computer will have a 4 year life and that it depreciates by 150 dollars yearly. So the computer will create an expense of 150 dollars every year. Thus reducing your net income over time.
The best advice I could give a small business owner is to basically define your company very clearly and have a set rule at the beginning where a purchase is an asset if it cost more than a certain amount. In addition to that you can also declare an asset an expense if you really need the tax break in a certain given period. Do ask your accountant before doing anything that might be questionable but as a rule of thumb as long as you declare real spending you will not get into any legal trouble.