There are two types of businesses: profit and non-profit. Both types of businesses incur expenses and generate revenues but they differ in terms of taxation. Depreciation is a tax-deductible and non-cash expense that is deducted from the profit a company makes.
Since non-profit organizations make no profits, one might think that they do not deduct depreciation on their assets. But the Financial Accounting Standards Board explains this differently.
According to Internal Revenue Service, IRS, there are different kinds of organizations that can be deemed as a non-profit and that includes employee benefit associations or funds, social welfare organizations, labor, and agricultural welfare societies, and political organizations.
Even though these organizations are working as non-profit, they are still required to provide accounting reports and records that highlight revenue generated, expenses, assets, liabilities, and cash inflow, and outflow.
Depreciating Fixed Assets in NPOs:
Because of the nature of non-profit organizations, certain long-term assets do not qualify for depreciation and hence aren’t listed as assets in the balance sheet either.
In fact, if any of these assets are up for sale, the revenue generated from them isn’t even recorded.
Following are a few examples:
- Certain works of art,
- Historical treasures,
- Historical buildings,
- Libraries and antiques in museums
However, for the assets that are depreciated, more than any other method, non-profits use the straight-line method for depreciation.
What is the Straight-line Method?
The straight-line method allows assets to be depreciated evenly over their useful life. So, you simply divide the cost of the asset less salvage value by the years of useful life and you get the amount that needs to be depreciated, or written off, each year.
The formula is as follows:
Depreciation = (Cost – Salvage Value) / Useful Life of Assets
Reporting Depreciation Expense Varies in NPOs:
Some organizations do not like writing off a non-cash expense and in some cases, an organization can have a tight budget so they decide to change their policies and not account for depreciation as it decreases the overall revenue, but they might have to reassess their needs for fixed assets in the future.
However, if an organization has a significant need for fixed assets, they should consider adopting or investing in a more accurate way to measure wear and tear on their assets.
A helpful tool can be SRP, Systems Replacement Plan. It is a tool that helps the engineers inspect the facility and any assets and identify any future wear and tear or maintenance issues and then they come up with a savings plan which incorporates the repairs and replacements needed over a specific period of time.
The organization can then put some funds aside for this kind of process, and that helps with budgeting as well.
Why Recognizing Fixed Assets Is Beneficial For NPOs?
According to FASB Statement 93, non-profits have to show the purchase of long-term assets in their statements, so that includes any assets that provide value for more than a year. This is known as capitalization.
So like in a normal organization, these capitalized assets have to be written off as well, as they’re being used.
This helps the non-profit organization to purchase fixed assets and not having to report it as an expense. So this helps in increasing net income on the income statement plus assets on the balance sheet.