When deciding whether to depreciate or expense farm costs, farmers must consider the nature of the expenses and their long-term goals. Including costs on an income statement reduce net income. The two approaches to managing costs include depreciation and expensing.
This guide is part of our series on The Basics of Agricultural Income Statements. Click Here to access a free downloadable Agricultural Income Statement.
To understand the difference between the two, take a look at the two definitions below.
Depreciating Costs
Depreciating farm costs, such as machinery or equipment, allows farmers to spread the expense over the asset’s useful life, matching the cost with the revenue it generates over time. This method provides a more accurate representation of profitability and asset value on financial statements. Additionally, depreciation can offer tax benefits by allowing farmers to deduct a portion of the asset’s cost each year. However, depreciation requires careful record-keeping and may result in lower net income in the short term.
Expensing Costs
On the other hand, expensing farm costs immediately, such as for seeds, fertilizers, or fuel, simplifies accounting and accurately reflects current profitability. This approach can also provide immediate tax deductions, reducing taxable income. However, expensing may overstate short-term profitability and fail to account for the long-term benefits of certain assets. Ultimately, the decision to depreciate or expense farm costs depends on factors such as the nature of the expense, tax implications, and long-term financial objectives. Farmers should carefully evaluate the pros and cons of each method to determine the most suitable approach for their operations.
Both methods affect the income statement by reducing net income, but they differ in their timing and the types of assets or expenses they apply to.
When to Expense versus Depreciate
Whether you should depreciate or expense depends on the nature of the asset or expense and your accounting goals:
When to Depreciate Costs
You should depreciate assets that provide long-term benefits to your business and have a useful life of more than one year. This includes items like buildings, machinery, vehicles, and equipment. Depreciating allows you to spread the cost of these assets over their useful lives, matching the expense with the revenue they generate over time. Depreciation can also provide tax benefits by allowing you to deduct a portion of the asset’s cost each year.
When to Expense Costs
You should expense costs that are incurred for short-term benefits or are consumed immediately. This includes items like office supplies, utility bills, rent, and salaries. By expensing these costs in the period they are incurred, you can accurately reflect the true profitability of your business during that time period.
Ultimately, the decision to depreciate or expense depends on your specific circumstances, accounting standards, and tax regulations. It’s important to consult with a financial advisor or accountant to determine the most appropriate treatment for your assets and expenses.
Further Reading
Understanding Farm Asset Depreciation and Tax Implications, Mississippi State University. http://extension.msstate.edu/publications/understanding-farm-asset-depreciation-and-tax-implications#:~:text=While%20depreciation%20is%20not%20an,taxes%20owed%20may%20decrease%20accordingly.
Depreciation Expense vs. Accumulated Depreciation: What’s the Difference?, Investopedia. https://www.investopedia.com/ask/answers/101314/when-should-i-use-depreciation-expense-instead-accumulated-depreciation.asp