Updated: Jul 7, 2022
What types of business purchases should you expense and which one should be depreciated? What is the difference between expensing and depreciating? How do you differentiate these in your accounting software?
For many business owners it can be challenging to learn all these accounting terms and to understand how each transaction should be categorized.
What is an Expense?
An expense is a purchase made by a company for which the payment is deductible from the same year’s taxes. For example, if you purchase a box of paper, a repair to your truck or dinner for your staff, these are expenses.
Typically, accounting software has several types of transaction categorizations, such as income, expenses, assets and liabilities. Office supplies purchased for use in your office, such as a box of paper, would be an expense, usually named Office Supplies or Office Expenses.
When your CPA gets your P&L at the end of the year, he or she will see that you expensed $XX on office supplies and add that to your tax forms to reduce that year’s tax liability.
What is Depreciation?
Depreciation is a slow reduction of the value of an asset over several years. The amount of depreciation of your assets for the year is calculated by your CPA and then added to your tax forms to reduce that year’s tax liability.
Examples of depreciable assets would be cars or trucks, computers, furniture, machinery, etc. These are items which have a higher cost and a longer life span than that of an expensed item.
Over the course of several years your CPA will calculate the depreciation on these types of assets until finally the entire amount has been deducted from your taxes.
The main difference, from the perspective of the business owner, between an expense and a depreciable asset, is that an expense is deducted from your taxes all at once, while a depreciable asset is deducted slowly over several years.
Where to Draw the Line
Knowing exactly when to expense a purchase and when to depreciate it can be tricky. My advice to your is when in doubt, ask your bookkeeper or CPA. But a couple things to bear in mind when trying to determine which is best:
1. Is this something that will get used up or something that will wear out? If it will get used up it will usually be an expense. Items that wear out are more likely to be depreciable.
2. How much did the item cost? Check with your CPA on this because I have gotten some differing answers from various CPAs, but a good rule of thumb is anything below $100 can be expensed while items at or above $100 need more consideration. Again, check with your CPA to get the baseline he or she recommends.
Categorizing: Expenses Vs. Assets
When entering transactions into your accounting software expenses will be those routine purchases that you need to run your business such as: office supplies; repairs and maintenance; insurance; legal fees; advertising, etc.
When categorizing assets it’s slightly more complex. There are two main types of assets, Fixed Assets and Other Current Assets.
A Fixed Asset is any tangible property with a useful life of over 12 months.
An Other Current Asset is one that is less tangible and likely to have a lifespan of less than a year. Some examples of Other Current Assets would be an employee advance, and advance payment to a supplier or a security deposit paid.
When considering whether to categorize a purchased item as an expense or an asset, generally Fixed Asset is the category that would be used, if the item is, in fact, an asset.
Expenses come off your taxes in the same year they were spent, and assets come off slowly over several years. Be sure to consult your bookkeeper or CPA when in doubt about the categorization of any transaction.
I hope this article has been helpful to you in making the right bookkeeping decisions for your business.
If you have any questions about bookkeeping or are considering hiring a bookkeeper for your business, please feel free to contact us at email@example.com.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.