Ice Cream Cone

The very word, depreciation, causes a certain glaze to fall on the faces of business owners. 

The mention of the word can invoke beaches and sunshine as the listener goes to their happy place while accountants talk.

It is no wonder then, after learning about managing your business, that the word depreciation is still a challenging subject.  Like the word basis, depreciation is “taxy” enough to cause the listener to think of literally anything but taxes.

Unfortunately, depreciation impacts so much of your business that you need to have at least a basic understanding of it.  So let’s make deprecation a bit more interesting using an analogy to something most everyone likes; ice cream.

Ice cream makes people happy.  Despite the health warnings, social ice cream eating continues to be an extremely popular activity.  On a sweltering July day in America, you will see people gathered at ice cream parlors cooling off by indulging in this delectable dairy dish.  

Like ice cream, businesses love depreciation.

Politicians love depreciation. 

Taxpayers love depreciation.  

They all have reasons for loving it, but the fact remains that it is enjoyed by all parties.

In order to make a comparison of depreciation, we need to distinguish between expenses and assets.  

Expenses are most outgoing money in a company.  Examples of expenses include payroll, office supplies, meals and utilities.  These are ongoing transactions that are “consumed”. Expenses are not expected to last for longer than one time period.  

Think of expenses as an ice cream cone. 

Cones are served one at a time in different sizes to be consumed at one time.  There are no leftovers and if you don’t eat the whole cone the rest goes in the trash.

Unlike expenses, assets are larger and (generally) more expensive items that last several years.  They include software, furniture, buildings, autos and many other items. The idea is this asset is made to last and will serve the business for longer than just one year. 

If normal expenses are ice cream cones, think of assets as tubs of ice cream.  

Unlike an ice cream cone, a tub of ice cream is not intended for one person to eat in one sitting.  The intention is that one person will purchase a tub of ice cream to use over a period of time while they serve one person or a small group of people.  

Now, what depreciation does is establish how much ice cream in the tub can be consumed in a given time period.  Depending on how the tub is categorized, the ice cream can be consumed faster or slower. Some tubs will give you more ice cream over a time period than others. 

To make matters even more challenging, the tax code includes things such as bonus depreciation and section 179 depreciation which allows a business to “eat all of their ice cream” at one time.  Like a child’s dream birthday party, the taxpayer gorges on all their depreciation in year one effectively consuming the whole “tub of ice cream” leaving nothing left for future years.

(In this analogy, the more ice cream in a given year, the less tax is paid.  Most businesses want to “eat as much ice cream” as possible in a year to lower their taxes but there are limits to its benefits.)

Tax planning then is really just party planning.  

How much ice cream do you want this year?  

Do you want to purchase more ice cream for next year or do you want to make this ice cream last?

Despite the inherently boring nature of the word, understanding depreciation really will save you money.  Managing your business well includes paying less in taxes. Knowing what depreciation is will help you plan and minimize your taxes.  

Now, I dare you to not think of depreciation when you order that next ice cream cone!