How Much Does a Car Depreciate in Value Per Year?
The Internal Revenue Service allows taxpayers to deduct the cost of equipment used in business activities up to a specific limit. If you use a car in your trade or business or to produce income, the IRS provides a mechanism through which you can lower your taxable income and fiscal debt.
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Definition
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Depreciation enables a business to allocate the cost of long-term assets over several years, also known as "useful life." This period is the number of years that a firm believes it will use a long-term asset in its operations. Only long-term assets, also called fixed or tangible resources, are subject to depreciation. Examples include cars, equipment and machinery. IRS guidelines for car depreciation limit the cost-allocation term to five years, using the straight-line method. This technique allocates the same cost amount every year. Conversely, the accelerated depreciation method enables companies to spread higher cost amounts in earlier years.
Accounting
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To record depreciation on a car that you use for business purposes, debit the depreciation expense account and credit the accumulated depreciation account. Depreciation expense is a non-cash item, meaning you don't pay for it, unlike charges such as rent, insurance and utilities. However, depreciation provides a net fiscal benefit because it lowers your tax bill.
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Financial Reporting
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Car depreciation accounting entries affect two financial statements. Depreciation expense is integral to the corporate statement of profit and loss, also known as an income statement. Accumulated depreciation is a balance sheet item. A balance sheet is also called a statement of financial position or statement of financial condition. Depreciating a corporate automobile also affects the statement of retained earnings, a data summary that provides insight into a firm's income and shareholders' equity capital.
Illustration
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You purchase a car on January 1 and intend to use it in your company's operating activities. The automobile costs $25,000 and meets all IRS guidelines for straight-line depreciation. At the end of the first year, the depreciation amount is $5,000, or $25,000 divided by five. To record the expense in your company's books, debit the depreciation expense account for $5,000 and credit the accumulated depreciation account for the same amount. Your firm's year-end income before depreciation amount is $105,000, and the corporate tax rate is 20 percent. Your income before taxes is $100,000, or $105,000 minus $5,000. The tax due is $20,000, or $100,000 times 20 percent, generating a net profit of $80,000. However, your net cash surplus is $85,000, or $80,000 plus $5,000, because you didn't pay for the depreciation expense.
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