Bookkeeping Insights - How Amortization and Depreciation Affects Your Year-End Tax Return
As we head down the stretch towards December 31, the year-end mandated by CRA for unincorporated businesses and a common year-end for incorporated companies, many business owners and managers are already thinking about their year-end tax returns. For businesses with a significant amount of equipment, depreciation and amortization can significantly affect profit or loss. Here’s a quick overview of what you need to know about these two business expenses.
What are Amortization and Depreciation?
Amortization and depreciation are business expenses applied to assets as a way to account for their diminishing value over a period of time. These assets serve the business for a period of several years and so their cost is expenses against the operation of the business over the expected lifetime of the asset.
Consider a business that spends $100,000 on vehicles for their service technicians to drive when they travel to their customer’s premises. It would affect their income statement if they allocated the entire cost of the vehicles during the same tax year, and it wouldn’t be accurate because those vehicles will enable them to service their customers and generate revenue for several years to come. Also, as soon as those vehicles are purchased, they become an asset to the business on the balance sheet, but over time they will lose value. The loss of value is the depreciation and is an expense of doing business.
Are Amortization and Depreciation the Same Thing?
While amortization and depreciation are very similar in that they both relate to expensing part of the value of an asset over its service lifetime, they are not exactly the same thing.
The difference between depreciation and amortization is that depreciation applies to tangible assets (things that you can touch) while amortization applies to intangible assets (things that you can’t touch). Vehicles, computer systems and production machinery are examples of tangible assets while patents, software licenses and service agreements are examples of intangible assets.
Another difference between the two is that amortization is usually expensed at a standard rate across the life of the asset (the straight line method) whereas depreciation is expensed on an accelerated basis – a vehicle will lose more of its value in the first year of service than it will in the seventh year, for example.
How to Calculate Depreciation and Amortization
Calculating depreciation and amortization isn’t always easy. When calculating how much the value of an asset will decrease over time you need to understand what the expected salvage value (the amount you would expect to sell it for at the end of its service life in your company) and how long you expect to own it. If the assets can be amortized or depreciated using the straight-line method then you simply divide the total expected depreciation value over the number of expected service years. If you’re using an accelerated expense model then you must find out how much of the assets value you can depreciate during each year.
The Canada Revenue Agency has rules and guidelines for calculating depreciation and amortization but to avoid costly fees, interest and penalties it’s important that you apply the correct model and use the right values. This is where a bookkeeper can really deliver significant value to your business by reviewing the assets that you own in your business and determining which should be depreciated or amortized and which should not.
While similar, depreciation and amortization are different ways to reduce the value of business assets over their service lifetime. Depreciation applies to tangible assets and amortization applies to intangible assets, and there are different ways to calculate both depreciation and amortization. By working with a bookkeeper you can make sure that you’re expensing the value of your business assets properly, avoiding costly penalties, fees and interested levied by the CRA.
Simply Bookkeeping1 provides professional bookkeeping services for freelancers, solopreneurs and owners of unincorporated and incorporated businesses. We customize our services based on your needs – we only see some of our clients a few hours a month but others we see on a more regular basis. Our services are reasonably priced and we tightly track the amount of time we spend working for you so you only pay for the services you get.
To learn more about us, please visit our website at www.simplybookkeeping1.com or contact Michele Hyde by phone at (647) 668 – 9363 or by email at firstname.lastname@example.org.
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