Depreciation does not directly impact a company’s cash flow. However, spreading the expense of a fixed asset over the years of its estimated useful life, depreciation affects the company’s tax liabilities, reducing cash outflows from income taxes (Nechaev & Rasputina, 2020). One of the depreciation methods is accelerated depreciation. By reducing the asset’s book value much faster than with regular linear depreciation, accelerated depreciation allows a company to reclassify assets, making it eligible to increase cash flow and defer federal and state income taxes.
For example, for a company buying an office space for $50,000 with the useful life of ten years, the depreciation expense would be divided over ten years at $5,000 per year. Depreciation expense would be debited for $5,000 each year, while the fixed asset accumulation account would be credited for $6,000. After ten years, the expense of the asset would be fully accounted for, and the asset’s worth in the books would equal $0. In this way, depreciation helps to avoid taking significant expense deductions on the income statement in the first year (Akan & Kiraci, 2022). Accelerated depreciation would yield similar results, except the yearly expense would be non-linear, accelerating either in the first or last years.
To ensure that all related financial details are allocated for and tracked, the process includes keeping account for the fixed assets, the depreciation claimed, and the adjusted tax value of each asset. It is essential to correctly state the asset’s purchase price, to determine the assest’s useful life time, and to assign relevant depreciation rate. A debit for depreciation expense for a required sum should be included in the yearly financial statements. A journal entry regarding a depreciated asset is to be passed at the end of the year. These steps will assist in making sound business decisions regarding depreciation.
References
Nechaev, A., & Rasputina, A. (2020). Integrated depreciation management system. IOP Conference Series: Earth and Environmental Science, 421(3). Web.
Akan, E., Kiraci, K. (2022). A novel depreciation approach in an uncertain environment: interval type-2 fuzzy sets in the maritime industry. Soft Comput, .Web.