depreciation

Depreciation, and its cousin amortization, are fairly obscure accounting terms. The most immediate and practical application they have to a craftsperson is as a deduction against earnings to arrive at income for tax purposes. Straight line, double declining balance, MACRS and ACRES methodologies are best left in the hands of the accountants. But what are they? Depreciation refers to charges against physical assets, while amortization refers to intangibles, such as computer software. For our present purposes, I'll speak only of depreciation, and then only in the economic sense, rather than the esoterics of tax methodologies. Let's assume a potter buys a new kiln costing $1,000, and further that this piece of equipment has an economic life of, say, five years, after which it's consigned to the scrap heap. Depreciation spreads the cost over the useful life of the asset, rather than charging it off entirely in the period the cost was incurred. A high priced item having a long life is capitalized instead of being expensed in the current period.

Now your eyes are glazing over. "So what", you say. Depreciation is one of those overheads that your margin/gross profit has to cover before you have pre-tax profits. You bought the kiln, and it is a part of your capital -- your investment in your business. But in five years you are going to have to buy another one, or you'll be out of business. Unless you account for depreciation in setting your prices, you won't have the cash flow to replace it when it wears out.

It's not necessary to tie yourself in knots trying the devise an internal method to account for your periodic depreciation expense. In most cases you can take the periodic charge and divide it by the number of units produced during that period. Or your machine may be rated to deliver you X number of units and then quietly expire, regardless of time periods. Suffice it to say that reasonableness is the issue here. Leave the convoluted shenanigans to your accountant to maximize the tax benefits of owning the machine.

   
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