CHOOSING A DEPRECIATION METHOD
Straight-line depreciation, which I illustrate here, makes for a good example in a book. It’s easy to understand and to illustrate. Most accountants and business owners use more-complicated depreciation methods, however, for a variety of reasons. One of the most important reasons is that tax accounting laws generally allow for depreciation methods that accelerate tax deductions.
You can figure out the annual depreciation according to one of these tax-based depreciation methods with your tax adviser’s help. Different rules apply to different types of assets. The rules that you use for a particular asset depend on when you originally purchased the asset. I recommend that you use the same asset depreciation method in QuickBooks that you use for your tax accounting. Depreciation is complicated enough as it is. You don’t want to be using one method of depreciation within QuickBooks for your own internal financial management and another method for your tax returns.
While I’m on the subject of depreciation, I should also mention that many small firms have the option of using something called a Section 179 election. (Section 179 is a chunk of law in the Internal Revenue Code.) A Section 179 election allows many businesses to immediately depreciate 100 percent of the cost of many of their fixed assets at the time of purchase. Despite the fact that a Section 179 election means that you can immediately write off the purchase of, for example, a $24,000 delivery truck at the time of purchase, you still want to treat fixed assets expensed via a Section 179 election the way I describe here. The difference is that you’ll immediately show the asset as fully depreciated — which means depreciated down to its salvage value or down to zero.
Journal Entry 11 debits an expense account called “Depreciation expense” for $1,000. Journal Entry 11 also credits a contra-asset account called “Acc. dep. — delivery truck” for $1,000. (By convention, because the phrase accumulated depreciation is so long, accountants and bookkeepers usually abbreviate it as acc. dep.) Note also that you need specific individual accumulated depreciation contra-asset accounts for each specific individual fixed asset account. You don’t want to lump all your accumulated depreciation together into a single catch-all account. Down that way lie madness and ruin.
Disposing of a fixed asset
The final wrinkle of fixed-asset accounting concerns disposal of a fixed asset for a gain or for a loss. When you ultimately sell a fixed asset or trade it in or discard it because it’s now junk, you record any gain or loss on the disposal of the asset. You also remove the fixed asset from your accounting records.
To show you how this works, consider again the example of the $12,000 delivery truck. Suppose that you’ve owned and operated this truck for two years. Over that time, you’ve depreciated $2,000 of the truck’s original purchase price. Further suppose that you’re going to sell the truck for $11,000 in cash. Table 3-12 shows the journal entry that you’d make to record this disposal.
TABLE 3-12 Journal Entry 12: Recording Fixed-Asset Sale for Gain
| Account | Debit | Credit |
|---|---|---|
| Delivery truck | $12,000 | |
| Cash | $11,000 | |
| Acc. dep. — delivery truck | $2,000 | |
| Gain on sale | $1,000 |
The first component of Journal Entry 12 shows the $12,000 credit of the delivery truck asset. This makes sense, right? You remove the delivery truck from your fixed-asset amounts by crediting the account for the same amount that you originally debited the account when you purchased the asset.
The next component of the journal entry shows the $11,000 debit to cash. This component, again, is pretty straightforward. It shows the cash that you receive by selling the asset.
The third component of the journal entry backs out the accumulated depreciation. If you depreciated the truck $1,000 a year for two years, the accumulated depreciation contra-asset account for the truck should equal $2,000. To remove this accumulated depreciation from your balance sheet, you debit the accumulated depreciation account for $2,000.
The final piece of the disposal journal entry is a plug — a calculated amount. You know the amount and whether that amount is a debit or credit by looking at the other accounts affected. In the case of Journal Entry 12, you know that a $1,000 credit is necessary to balance the journal entry. Debits must equal credits.
If the plug was a debit amount, the disposal produces a loss. This makes sense; a loss is like an expense, and expenses are debits.
If you’re confused about the gain component of Journal Entry 12, let me make this observation. Over the two years of use, the business depreciated the truck by $2,000. In other words, the business, through the depreciation expense, said that the truck lost $2,000 of value. If, however, the $12,000 delivery truck is sold two years later for $11,000, the loss in value doesn’t equal $2,000; it equals $1,000. The $1,000 gain essentially recaptures the unnecessary extra depreciation that was charged incorrectly.
You can enter journal entries 11 and 12 as journal entries within QuickBooks by using the Make General Journal Entries command.
Recognizing Liabilities
Liabilities are amounts that a business owes to other parties. If a business owes a bank money because of a loan, that’s a liability. If a business owes an employee wages or benefits, that’s a liability. If a business owes the federal, state, or local government taxes, those are liabilities.
Borrowing money
Liabilities, fortunately, aren’t too tricky to record after you’ve seen how the journal entries look. Table 3-13, for example, shows how you record money borrowed on a loan. In the case of a $10,000 loan, you would debit cash for $10,000 and credit a loan payable liability account for $10,000.
TABLE 3-13 Journal Entry 13: Borrowing Money via a Loan
| Account | Debit | Credit |
|---|---|---|
| Cash | $10,000 | |
| Loan payable |
|
