Charles Hall is a CPA who heads up an excellent blog by the name of CPA-Scribo. His mission is to assist small- to medium-sized CPA firms with accounting, auditing, fraud and technology issues. We here at Depreciation Guru think he does an excellent job! In a recent post he tackled the topic of funding depreciation. What exactly is funding depreciation you may ask? Read on.
It’s the setting aside of cash in amounts equal to an organization’s annual depreciation. The purpose: to fund future purchases of capital assets with cash.
Suppose you buy a $10,000 whiz-bang gizmo – a piece of equipment – that you expect to use for ten years, and at the end of the ten years you expect it to have no value. Your annual depreciation is $1,000.
The smart manager will annually set aside $1,000 in a safe investment – such as a certificate of deposit or money market account – for the future replacement of the whiz-bang gizmo.
If the company does not annually invest the $1,000, it has a few options at the end of the ten-year period:
- Borrow the full amount for the replacement cost
- Seek outside funding (e.g., grants)
- Use other funds from within the organization
- Ask U2 to do a special benefits concert – just kidding
Businesses that fund depreciation are always making money from interest (granted not much these days) rather than paying for it.
Another advantage to funding depreciation: you know you will have the money to purchase the capital asset. You’re not concerned with whether a creditor will lend you the money for the acquisition. You’re financially stronger.
So who should fund depreciation?
Organizations with sufficient cash flow and discipline. It’s the smart thing to do.
Questions? Comments? Let us know in the comments section below.
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