What is Depreciation? (also… how to fold a fitted sheet)

I have talked a lot lately about capital assets. Well you cannot talk about capital assets without talking about Depreciation. Depreciation is a very important concept in accounting, so I am going to be breaking it down for you in this video. WATCH NOW!

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VIDEO SUMMARY

I want to start this video by showing you why it is good to have friends who are accountants. Accountants have a secret super power. They tend to be very good at explaining things in a systematic and rational way. As an example of this, I am going to start out by explaining how to do a very basic life skill that a lot of people have a hard time with: How to fold a fitted sheet.

I have a fitted sheet here. It is just a plain white sheet. I do not know who designed these things, but they are almost impossible to fold nicely, because they have these elastic corners. I am going to show you how to fold these in three simple steps. You can follow these three simple steps every time, and you will end up with a nicely folded sheet.

1. Find the four corners. You can see I have folded all four corners into each other and am holding them in one hand.
2. Shake the sheet. If you are holding the four corners the sheet will naturally fold itself into a square allowing you to grab the opposite end.
3. Fold two times. Once you have the first square, it is easy to fold it over two more times to get a nicely folded sheet.

So those are the steps:

1. Find the four corners
2. Shake the sheet
3. Fold two times

What I have done here is I have taken an activity that is very confusing and difficult for people, and I have laid out a simple process in a systematic and rational manner that you can follow every time and end up with a folded sheet. This skill of describing something in a systematic and rational way is a skill that accountants are very good at, and it is essentially how you do depreciation.

What is depreciation? Whenever you buy a capital asset, you are going to depreciate it every year. So each year you will write a set of financial statements and you will record that year’s depreciation. Sounds simple right? Well there are actually a lot of different ways you can calculate depreciation.

Here are some examples:

1. Straight line
2. Modified Accelerated Cost Recovery System (MACRS)
3. Activity method
4. Sum-of-the-years’-digits
5. Composite method
6. Many more
7. Your own method…

So there is a lot of different methods to calculate depreciation. Well, if you are a business owner, and you look at this list, what are you supposed to do? What depreciation method are you supposed to use? The short answer to that question is you need to hire a good accountant, because accountants are really good at this.

Let me explain what is going on in a big picture level. We are going to talk about GAAP for a minute.

Quick tip: GAAP stands for Generally Accepted Accounting Principles. These are the accounting rules that are followed in the United States.

GAAP talks about depreciation methods. What GAAP says is that a business must depreciate their assets in a systematic and rational manner. So there is flexibility here for businesses to choose the depreciation method that is the best fit for their business and their industry. But you have to choose a method that is systematic and rational.

Now I am going to get really personal here. We started out by folding a fitted sheet. Now I am going to show you my linen closet. In my opinion, you can tell a lot about someone’s character by the state of their linen closet. So let’s take a look at mine.

Here is my linen closet. I do not need very many sheets or towels, and I do not have anything very fancy. But one thing you will notice is this is fairly neat and organized. I am trying to make a point here. When you have a process that does things in a systematic and rational way, what you end up with is something that is neat and organized. Your job as an accountant is to take a business and make it neat and organized. We are talking about depreciation, which is a complicated part of accounting. You are taking your financial statements and making them neat and organized. It is a very useful skill to have and the reason why it is always good to have a friend who is an accountant.

Leave a comment down below letting me know what you think!

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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.