Depreciation and amortization

• Author: Nicholas L. Bourdeau
• Pages: 139-156

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Chapter 10

Depreciation and Amortization

TABLE OF CONTENTS

§10:00 THEORY

§10:01 Business Use

§10:02 Expense vs. Capitalization

§10:03 Battle Lines

§10:04 Accelerated Depreciation

§10:10 FORM 4797—SALES OF BUSINESS PROPERTY

§10:20 BUILDING DEPRECIATION

§10:30 AMORTIZATION

§10:40 DEPLETION

§10:50 LINE BY LINE

§10:50.1 Lines 1 Through 12 Section 179 Expense Deduction

§10:50.2 Line 14 Special Depreciation Allowance

§10:50.3 Lines 15 Through 23

§10:50.4 Lines 24a Through 41

§10:50.5 Lines 42 Through 44

§10:60 THE INVESTIGATION

FORMS

QUICK TAKE

Most businesses require physical (real) assets to operate. Examples can include desks,

chairs, vehicles, manufacturing equipment and buildings. Depreciation is the means by

which businesses recognize the cost of these assets as deductions from income. The Internal

Revenue Service rules governing depreciation are complex and have consequently made

this area a challenge for child support investigators. However, by understanding a few basic

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§10:00 The Determination of Income for Child Support 10-2§10:00 The Determination of Income for Child Support 10-2

§10:00 THEORY

Most businesses require assets to operate. The

type of asset required depends on the business

being operated but can include buildings, automo-

biles, computers, furniture, tools, or machinery.

These assets are sometimes referred to as capital

assets, real assets or hard assets. Depreciation is

the means by which businesses recognize the cost

of these assets. For example, assume that a busi-

ness owner purchases a machine to package his or

her product. The machine shrink wraps sports bags

and is expected to last (have a useful life of) about

five years. Assume that in Year 1 the owner writes

a check for $100,000 to purchase the machine.

In that year she will be able to deduct on her tax

return $20,000 of depreciation expense associated

with the packaging equipment. She will also be

able to deduct $20,000 in Year 2 through Year 5.

concepts, investigators can effectively review and adjust depreciation claimed by businesses

to levels that are acceptable or allowed for the determination of child support.

WHAT YOU SEEK

Internal Revenue Service Form 4562

Business Depreciation Schedule

RESOURCES

Instructions to Form 4562

Publication 946, How to Depreciate Property

Year 1 Year 2 Year 3 Year 4 Year 5 Total

20,000 20,000 20,000 20,000 20,000 100,000

The reason depreciation was developed as an

accounting theory was to match costs with revenues.

That is, the business owner is going to use the equip-

ment for five years. If the business owner recognized

all of the expense of the equipment in the year it was

purchased, then the expenses for that year would

be very high and, therefore, understate income.

Similarly, the equipment is being used in Year 2

through Year 5, but no costs associated with the

machine are being recognized. Consequently, the

income for those years will be overstated. Therefore,

depreciation is simply the means of recognizing the

cost of assets over the years that they are being used.

The calculation above is an example of

straight line depreciation. That is, the depre-

ciation for each year is the same until the asset

has been fully depreciated. However, there are

a number of depreciation methods that allow

owners to write off equipment faster than the

straight line method. These methods are referred

to as accelerated depreciation. In essence, these

methods allow business owners to claim more of

the cost of assets earlier in the life of the assets.

For example, assume that a business owner

purchased an asset for $3,000. The straight

line method would yield an equal write off per

year. The accelerated method when compared to

straight line would provide for more write off in

the first year, the same in the second year, and

less in the third year of the asset life:

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