Depreciation Methods for Startup Businesses

        When starting a business there are many aspects that need to be initiated.  A company must come up with their product or service.  A business plan must be created which can be implemented.  Startup capital is necessary to get the fundamental equipment needed.  Another aspect is the handling of accounting functions for the fledging business.  There are many different aspects of accounting for a business one of which is depreciation.

            Depreciation is the method of allocating the cost of an asset over its useful life.  These assets can be the equipment that a new business will utilize to get started.  Businesses depreciate assets for both tax and accounting purposes.  Depreciation is shown differently between a balance sheet and a income statement.

            Depreciation is represented on a balance sheet by an accumulated depreciation account.  This is a contra asset and shows the cumulative total of all the depreciation expense that has been recorded for the asset since the organization first took ownership of the asset.  Depreciation on a income statement is reported as a separate expense item.  Depreciation is reported as a separate expense item because these expenses do not result in disbursement of cash. 

            Businesses can calculate depreciation through a variety of forms based on levels of activity, expected units of production or the passage of time.  For the purposes of this discussion, this paper will focus on straight line depreciation and double decline depreciation.

            Straight line depreciation is one of the most frequently used methods for calculating depreciation expense. To calculate depreciation using the straight line method one must first deduct a salvage value from the newly acquired asset. Once the salvage value has been subtracted one will divide the cost of the asset by the amount of years the asset will be considered useful.  The result one achieves once the calculation has been completed will be considered the annual depreciation expense.  This differs from the double declining method.

            Double declining balance is a method of depreciation where during the early years of an asset there is a higher depreciation expense and therefore a lower net income.  During the later years of the asset's life the annual depreciation expense using the double declining method will be less than the straight line method.  When calculating the double declining method, it's initiated as straight line method and then the total percentage of the asset that is depreciated the first year is figured out and doubled.  Each subsequent year, that same percentage is multiplied by the remaining balance to be depreciated.  Each year of the life of the asset the double declining rate will be recalculated against the net value at the end of the previous year.  Utilizing this method each year, the depreciation expense will be less than the prior year's for the remainder of the asset's life.  The question startup businesses have to ask is what method or methods are preferable to their operation.

            There are many advantages for a new organization to use straight line depreciation.  One of the advantages is that calculating straight line depreciation is very easy because the asset is evenly expensed throughout its useful life.  Therefore the company will use the same numbers for depreciation each year.  This reduces the amount of work and time spent on the organization's financial statements.

                        Straight line depreciation is an advantage to organizations regarding income statements in the early years of an assets use.  Straight line depreciation will have a higher net income in earlier years because the depreciation expense will be lower.  This is advantageous for startup businesses that wish to show a higher net income in their first years especially in regards to promoting themselves to new investors.

            Another item new businesses must focus on is forecasting.  Organizations forecast by attempting to predict the future performance of a business, usually by looking at figures.  By using straight line depreciation forecasting becomes much simpler.  It is easier for the organization to look ahead as the asset is evenly expensed over time.  There are taxation advantages in using the double declining method.

            Double declining is often used by companies for tax purposes. Because the depreciation expenses are larger in the early periods of the asset's useful life, the tax savings are greater in the beginning of the depreciation cycle and the tax benefits come sooner.  This can be a great advantage to a startup company as it will maximize tax refunds and minimize the amount distributed in cash to pay for additional income taxes.  Some businesses will take advantage of both methods of depreciation.

            Utilizing both methods of depreciation can be beneficial for organizations.  A firm will use straight line depreciation for financial statements and double declining depreciation for taxation purposes.  This will give a business both the ability to show the higher net income through straight line depreciation while taking advantage of tax benefits from the double declining method.

            There are many different ways with differing benefits for startup companies to calculate depreciation.  An organization must review all the available options and make an educated decision on what is best.