Depreciation is the practice of accounting for an asset’s cost incrementally. To explain, imagine you spend $10,000 on equipment for your business, and you anticipate the equipment will last five years. Rather than recording the entire expense in your accounting records right away, you decide to record a $2,000 equipment expense annually for the next five years as the equipment depreciates. This accounting strategy gives you a more accurate representation of your annual profits and expenses. In contrast, if you write off the entire purchase the first year, that artificially lowers profits that year while overstating profits in future years. You can depreciate assets based on their useful life as explained above. Alternatively, you can depreciate assets based on their current sales value. To continue with the above example, if you purchase a $10,000 piece of equipment and its resale value is $7,000 the second year, you write off $3,000 for the first year of ownership and continue this pattern until the expense is fully recorded. The Canada Revenue Agency organizes depreciable business assets into classes, and the class determines the portion of the expense to be written off each year. For example, buildings in class 1 have a depreciation rate of 4% per year, while computer hardware in class 10 has a depreciation rate of 30%. To simplify your accounting process, you may want to use the same depreciation rates as the CRA.
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