Video instructions and help with filling out and completing Can Form 4797 Depreciation

Instructions and Help about Can Form 4797 Depreciation

Hi I'm sue Ling Hui principal and founder of cash flow gum fool in this video you learn what depreciation is and how it affects your business's finances particularly profit and cash flow depreciation applies to fixed assets on your balance sheet this group of assets is also called property plant and equipment or PPE and E for short there are items that you buy to use in your business to help generate income for more than twelve months examples of fixed assets include land and buildings plant and equipment furniture fixtures and fittings computers motor vehicles trucks and so on the word fixed doesn't mean that they're not physically movable it means they are part of your long-term business assets that's why they fall in the non current assets part of your balance sheet whether an item is a fixed asset or not depends on what is used for in the business for example a car dealership buys and sells cars to generate income these cars are bought by the business for the purpose of selling them as quickly as possible at a profit so they are part of the business's stock or inventory the dealership would also have its own cars for use by the business these cars would be part of the business's fixed assets it's the business purpose of the item that determines whether it's part of inventory or fixed assets all fixed assets have finite useful lives land is the exception depreciation is an accounting concept which spreads the cost of a fixed asset over the term of that assets useful life the length of the useful life depends on the asset for a computer it might be three years a bottling line eight years a building may be twenty years the reason for spreading the fixed assets cost is to match expense with income the car or computer or a building will be used in the business to generate income for more than one year in other words the cost is an expense that's related to future income in your business so it shouldn't just be expensed in the month that you buy it imagine what it would do to your business profit if you charge the entire cost of a factory as an expense in one month there are various ways for spreading the cost over the useful life you could use the straight-line method the declining balance method or the units of production approach these are just three examples out of a range of possible basis of depreciation each method spreads the depreciation expense out in a different pattern over the years of the useful life tax and accounting rules set out what the useful life of an asset is and the appropriate basis of calculating depreciation your accountant will know what applies to your business fixed assets let's use a car as an example to see the effect of depreciation on your financials I'm going to use a simple balance sheet so that we can focus only on fixed asset that's the car and depreciation let's say the business already has four thousand dollars in cash and that cash came in by way of capital you put in your business buys the car for use in the business on the first day of January the car costs $4,000 the car will show up in your balance sheet under fixed assets in your cash flow statement the cash flows for that first day of January will show the purchase of the car as capital expenditure under investment activities now a car can't just magically appear on your balance sheet the next question is how did the business pay for it well you could use that cash on hand but that would mean you run your cash balances down to zero alternatively you could do it by way of a financing facility from the bank that means you'd have cash inflow from the bank loan and bank borrowings as a liability on balance sheet net cash flow as a result of the purchase of the car would then be 0 or maybe you as a shareholder could make a loan or $4,000 to the business to buy the car in this case your cash flow statement would show cash inflow from a loan from shareholders and you'd see that load as a liability on the balance sheet for the purposes of this exercise let's assume that you as a shareholder lend the money to the business this way we don't run the business cash balances down to zero and we also don't incur bank debt let's say the car has the useful life of four years for accounting and tax purposes it's expected to have no value left at the end of four years so that means it will appreciate or reduce in value by a thousand dollars a year assuming we use what is known as straight-line depreciation this basis of depreciation simply means that the cost of the asset is depreciated in equal amount over its useful life so in this instance the value of the car in your account will be reduced by a thousand dollars a year and by the end of year four it's worth zero in your accounts your business still has the car at the end of year four even though it has zero value on the books so how does an investment in a fixed asset like a car and its associated depreciation affect your financials here's a profit and loss with some simple sales and expense numbers I'm holding these numbers constant across the period so that we can focus on depreciation we are also going to ignore income tax for the purposes of this exercise depreciation expense is a way of allocating the cost of the car over its useful life so in this example we have annual depreciation expense of $1,000 in your profit and loss for four years over these