If you’re frustrated by a massive depreciation expense throwing off your restaurant’s P&L, this article is for you. CPAs commonly record tax depreciation in their clients’ books so that the tax returns match the financial statements. Tax depreciation is generally higher than book depreciation due to the accelerated depreciation system allowed by the IRS. The bonus and section 179 depreciation incentives exacerbate this issue by allowing businesses to depreciate 80-100% of their fixed assets in the year they’re placed in service. Fortunately, there is an alternative. You can take advantage of tax depreciation while maintaining your financials on book depreciation. You will need a fixed asset policy to record book depreciation throughout the year. It’s a little more work, so you might get some pushback from your tax accountant. But stand your ground, my friend, it’s all worth it. In this article, we offer you a step-by-step fixed asset policy so you know how your fixed assets should be accounted for and your P&L is telling you the truth.
Step 1: Determine whether a purchase is a fixed asset
Determining whether a purchase is a fixed asset significantly impacts your financial statements. A fixed asset is recorded on your balance sheet and depreciated over its useful life, not expensed immediately on your profit and loss statement.
A fixed asset is defined as any tangible asset purchased for use in day-to-day operations over a specified amount, and that will yield an economic benefit over a period greater than one year. Setting a specified amount between $2,500 and $5,000 is common. We use $2,500 for our clients because it is consistent with the amount the IRS allows you to deduct if you don’t have GAAP audited financial statements and a de minimis safe harbor election in place. However, your asset policy could set any specified amount that is reasonable. We’ll refer to this specified amount as the threshold.
Fixed Assets include but are not limited to property and equipment such as buildings, build-outs, renovations, dining room furniture, kitchen equipment, fixtures, computers, POS systems, and other equipment.
Items routinely purchased and disposed of as a set, in amounts over your threshold, will be classified as a single fixed asset and depreciated over the its useful life. For example, assuming your fixed asset threshold is $2,500, if a dining table and four chairs are purchased from the same vendor as a set (the chairs can’t be used without the table), and the dining table cost is $1,500, and the cost of each chair is $250 for a complete total of $2,500, then this purchase would be considered a single fixed asset called “Dining Table and Chair Set” with a cost basis of $2,500. The total costs will be depreciated over the life of the asset.
Purchases less than the threshold amount that are not routinely purchased and disposed of as a set are expensed in the period acquired. For example, assuming our fixed asset policy requires us to capitalize any purchase over $2,500 as a fixed asset, a single accent chair not part of a set purchased for $2,000 could be expensed as small furniture or supplies on the profit and loss statement.
This same principle applies to leasehold improvements, build-out costs, and renovations. If the purchase is an improvement, it must be capitalized as a fixed asset or expensed as repairs and maintenance. We suggest following the IRS’ Tangible Property Regulations to determine this. All the capitalized expenditures routinely purchased and disposed of together will be considered a single fixed asset. For example, if a restaurant has one thousand transactions for $100 each at Home Depot buying supplies to renovate a dining room, the fixed asset cost basis is $100,000 and is named “Dining Room Renovation”.
Step 2: Determine the cost basis of the fixed asset
The asset’s cost basis is determined by including the purchase price of the item, transportation costs, installation costs, and any other direct expenses incurred in obtaining the asset. For example, if a restaurant purchases a freezer for $3,000 and then pays $1,000 for plumbing parts and labor to install it correctly, the entire $4,000 is capitalized as a single fixed asset as long as the total amount exceeds the fixed asset policy threshold. Subsequent items purchased, which fall under the fixed asset policy threshold, are expensed immediately and not capitalized. Using the same example above, if the freezer is repaired three months later for $1,000, then that $1,000 is expensed to Repairs & Maintenance.
New Construction and Leasehold Improvements
When a restaurant constructs a depreciable asset, all direct costs are included in the total cost of the asset. This includes architectural, engineering, legal, consulting, project management from outside sources, etc. Fixed overhead costs are not included in the asset’s capitalization.
Step 3: Determine the Useful Life, Salvage Value, and Depreciation!
Once you know the cost basis of your fixed asset, you can classify it into an account or accounting category. The asset accounts for restaurants and bars are:
- 1510 Land
- 1520 Building
- 1530 Leasehold Improvements
- 1531 Land Improvements
- 1540 Furniture and Equipment
- 1541 Office Furniture and Equipment
- 1545 Off the Shelf Software/Website
- 1550 Automobiles and Trucks
- 1560 Artwork
Once you have classified the fixed asset into an accounting account, you must determine each fixed asset’s useful life and salvage value to know how much of the fixed asset to depreciate and over how long.
Salvage Value
The salvage value is the disposal value at the end of a fixed asset’s useful life. This amount is subtracted from the cost basis of the fixed asset to determine the depreciable basis. It must be a reasonable estimate. For book purposes, the lower the salvage value, the more conservative you are because you overstate your depreciation. We like to set the salvage value at zero for most assets to simplify the book depreciation process.
Useful Life
We prefer to stick with the IRS recommendations for useful life, as shown in the IRS Cost Segregation Audit Technique Guide. Based on this guide, you can generally apply a useful life by asset account or category as correlated below:
- 1510 Land – N/A-not depreciable
- 1520 Building – 39 Years
- 1530 Leasehold Improvements – 15 Years
- 1531 Land Improvements – 15 Years
- 1540 Furniture and Equipment – 5 Years
- 1541 Office Furniture and Equipment – 7 Years
- 1550 Automobiles and Trucks – 5 Years
- 1560 Artwork – N/A-not depreciable
Depreciation
To keep things simple and streamlined, we suggest calculating depreciation using a straight-line method. Under this method, simply divide your depreciable cost basis over its useful life in months to get your monthly depreciation expense.
Conclusion
It’s as simple as that! These steps provide you with a fixed asset policy to get your restaurant’s P&L and Balance Sheet reporting more realistic net income and asset values. You will need a fixed asset software or a spreadsheet to track your fixed assets and book depreciation. If you’d rather take depreciation calculation and concerns off of your place, contact us to learn more about how we manage your book depreciation and fixed assets for you.
