Appreciating Depreciation
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Practice owners have so much on their plate that a lot of times only the bare minimal is done to keep their books accurate. Many details are simply ignored because they are time-consuming, and one thing a vet practice owner doesn’t have a lot of is time. However, so many of these details are necessary in order to save the practice thousands of dollars. One of those details is recording the depreciation expense of your fixed assets. If you don’t record the depreciation expense, your practice will show a higher number in net income. We all know what that means. You will have more to pay in income taxes. This is why I appreciate depreciation expenses! The higher the depreciation expense, the lower your net income, which means less taxes. That sounds good to everyone, right? So let’s dig in deeper and learn more about depreciation expense.
Depreciation is the methodical reduction in the recorded cost of a fixed asset. This is recorded in order to match the cost of the fixed asset with the revenue that it brings to the practice. We record expenses with their matching revenue in order to always have a clear and accurate picture of the financial status of the practice. However, since it is pretty tricky to figure out an exact amount for how much a fixed asset cost is matched to a revenue-generating activity, what we do is record a steady amount of depreciation over the useful life of each fixed asset. By the time the fixed asset has reached the end of its useful life, the books should only show the salvage value of the fixed asset.
To sum up, you want to make sure to record the depreciation of your fixed assets so that your books accurately reflect the value of your practice. Now that you understand the importance of doing so, let me go over the three questions you have to answer in order to get started.
What’s the useful life of the fixed asset?
What’s the salvage value of the fixed asset?
What depreciation method do you want to use?
Question #1 - What’s the useful life of the fixed asset?
This means that you have to figure out how many years the asset will be productive. After a certain amount of time, it is no longer financially smart to continue operating an asset and it will be more cost effective to dispose of it.
Question #2 - What’s the salvage value of the fixed asset?
When your practice finally decides to dispose of an asset once it has reached its useful life, it may be able to sell it for a reduced amount (its salvage value).
Question #3 - What depreciation method do you want to use?
There are two methods of depreciation: straight-line depreciation and accelerated depreciation.
Straight-line depreciation is pretty simple to follow. You calculate the amount you will expense by subtracting the salvage value from the asset value and then dividing that amount by the total of useful years of the asset. You then expense this same amount each time. This is by far the easiest method of depreciating an asset.
Accelerated depreciation is a method where the asset loses book value at a faster rate than through the straight-line depreciation method. There are several reasons to choose this form of depreciation. One reason is when practices have assets that they expect to be more productive during the earlier years and less productive towards the end of its useful life. A second reason is that this form of depreciation helps practices defer income taxes during the earlier years of the asset. The higher the depreciation expense, the lower the net income, which means less income taxes to pay. However, during the later years of the asset, the depreciation expense will be lower, which will mean more income taxes.
To break it down to the most simple terms, depreciation is an expense that will lower your practice’s net income. Of course, the lower your net income the less you will pay in income taxes. So unless you don’t mind paying more in taxes than you actually need to, I would suggest that you talk to your accountant and bookkeeper to make sure that this expense is being methodically reflected in your books. If you are looking for a bookkeeper to take all of these concerns off your plate, send me an email at rbailey@veterinarybookkeepingsolutions.com. I would be happy to help!