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IT Budgeting Part 2: Depreciation

This blog is for the IT people!  Don’t turn away because the topic is accounting!  If you are the accounting-type, this is an introductory discussion that we hope will open up a discussion with your IT people.

As an IT professional you probably don’t deal with the concepts of fixed assets and depreciation every day. Usually these terms are reserved for members of your accounting/finance department.  While it’s not essential for you to know everything about these financial concepts, understanding the basics can help you better understand your company’s financial decisions.

Simply put, a fixed asset is anything with a useful life more than one year.  These items are often large in cost, are frequently budgeted for, and are rarely sold to customers.  Accounting requires a business to capitalize (record as an asset of the company rather than an expense) these items because they will benefit future periods.  Some popular examples of fixed assets in the IT industry include: servers, routers, racks, and workstations.

Depreciation is a related concept to fixed assets and is defined as “…the allocation of the cost of assets to periods in which the assets are used…”  In other words, we are trying to match the expense to when you use it. Important note: there are often 2 sets of books (it’s OK, this is not bad), one for accounting purposes and the other is according to tax rules.

Now to help reinforce these concepts let’s review an example.  Let’s say ABC Company purchases a new server on January 1, 2012 for $5,000.  The server has an expected useful life of five years and will be depreciated over the five years using straight line depreciation method.  Now most companies would prefer to take the entire $5,000 purchase and record it as a current year expense.  Unfortunately, for financial purposes, the business must capitalize the $5,000 purchase and record depreciation of $1,000 each year until there is no remaining balance.

Now, you may be asking yourself “why does this matter to me?”  While the actual cash outlay on the server in the example above was $5,000, the amount recorded on the company’s current year income statement is only $1,000.  In your budgeting process, you may be looking at your expenditures (money out the door) and expenses (that is what is in the expenses vs. budget reports).

This is obviously overly simplified but this may help the discussion during the budgeting process.