The 101 on Depreciation Expense and Fixed Assets

By Freed Maxick on July, 22 2013
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Freed Maxick provides accounting, auditing, tax and consulting services and serves public and private companies, not-for-profits and municipalities to enhance profitability, save taxes, improve accountability and preserve wealth.

By: Rodney Collins

Fixed assets are a common source of loan collateral. But when a business has to account for equipment, plant and property, it can be tricky. IRS and FASB rules allow some leeway when deciding whether to expense or capitalize a purchase, as well as choosing the depreciation methods.

To expense or capitalize … That is the question

Deciding whether to expense or capitalize a purchase is subjective. If an asset is above a certain dollar amount (which will vary from company to company) and is expected to have ongoing use to the company beyond the current period, it technically should be reported on the balance sheet and then gradually depreciated over its expected lifespan.

On the other hand, some purchases are expensed in the current period, typically as maintenance or supply and repair expenses. Immediately expensing those purchases will lower the borrower’s profits compared to capitalizing purchases.

Keep in mind that repairs and maintenance are “hot buttons” with the IRS. Internal Revenue Code Section 263(a) classifies maintenance and repair spending as a “capitalizable improvement” if it lengthens the duration that the client can use it as an asset, adds to an asset’s value, or adapts an asset to a different use.

Choosing book or market value

When a client capitalizes a fixed asset, the amount shown on the company’s balance sheet reflects the original purchase price minus any depreciation expense that has been taken over the asset’s life. If the borrower uses accelerated tax depreciation methods for book purposes, the balance sheet may significantly understate a fixed asset’s ongoing value to the company.

A gift from Uncle Sam

The American Taxpayer Relief Act, or simply ATRA, allows businesses to write off up to $500,000 of qualified fixed asset purchases in 2013. The write off is subject to a dollar-for-dollar phase-out above $2 million. For any purchases above that $2 million, clients can write off half the purchase price under ATRA’s bonus depreciation provision.

Certain federal stimulus programs have been permitting expanded tax depreciation allowances since 2008. So if a borrower uses tax depreciation methods for book purposes, the balance sheet may report zero value for items that were purchased over the last six years. The good news is that many of these fully depreciated items will continue to benefit the client for years to come.

Moreover, profits can be quite low in the year that Section 179 or bonus depreciation deductions are taken.

Understand the law

In order to fully understand what’s happening with a borrower’s fixed assets and depreciation methods, you need to dig deeper. Fixed asset appraisals are essential if clients pledge them as loan collateral. If your bank accepts fixed assets at face value, you might make some bad decisions about the profitability, collateral values, and overall creditworthiness.

Freed Maxick’s Asset Based Lending division is one of the nation’s largest providers for field exam outsourcing services. If you have questions regarding your fixed assets, depreciation expenses or any other asset based lending issue, give our Buffalo NY office a call at 716.847.2651, or you may contact us here.

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