The Investment Value of Fixed AssetsJuly 19, 2019
Contractors, take a look at your balance sheet. Your fixed assets—such as your property, plant and equipment—have been the basis of numerous tax law changes in recent years. They also provide an all-purpose planning tool for you as a business owner.
While the new laws allow us to depreciate or write off equipment purchases sooner, we want to look at ways to hold the value of these items on your books, thus increasing your net worth. Significant dollars are invested in the property acquired by a contractor, and that value is as important as cash or contracts receivables.
Favorable but Not Final
The Tax Cuts and Jobs Act of 2017 provided huge write-off incentives to tangible personal property. Fixed assets with a useful life of 15 years or less are now allowed a 100% write-off of the cost basis under tax depreciation rules. Provided that the asset was new and necessary in the trade or business, the owner could deduct from taxable income the entire purchase price of their equipment acquisitions. However, these favorable tax considerations should not be the end of the planning process for a contractor. Rather, there are a host of additional items warranting further consideration. Let’s examine a few of them and envision how these pieces fit together.
Timing is Everything…
While the deferral of taxable income is often a large topic of conversation prior to year-end, the financial statement or book income needs a few moments of attention. By electing bonus depreciation for tax, timing differences are created under Generally Accepted Accounting Principles (GAAP) for financial statement reporting practices. These timing differences create the need to record the future deferred tax charges on a company’s profit. So, when tax depreciation is higher than the books, we see a deferred tax charge being recorded. Accelerated depreciation allows us to take more expense today and postpone recognition of taxes on profits until later periods. GAAP has us adjusting the measurement to reflect this future liability.
…And Speed Isn’t
Since often our financial statements are evaluated by banking and surety underwriting standards, deferred tax liabilities, both current and long-term, impact areas of liquidity like the current ratio and working capital calculations. While the deferral of taxable income reduces current tax expense and improves current cash, it may not be the best answer for the business. Maybe the combination of using the Internal Revenue Service established MACRS tables and Section 179 depreciation allows a contractor to obtain the same deferral of taxable income. By using a slower method, we get a residual depreciation expense in a subsequent tax year.
An additional consideration for book reporting is the establishment of salvage value. Rarely, after a 5-7-year period, is a piece of equipment more than a pile of scrap iron. Many assets have either trade-in values or auction values; identifying a salvage value before book depreciation is calculated will reduce the depreciable charge of an asset for GAAP reporting benefits. It will also increase the net book value of the asset, which will improve the carrying value and correctly provide the appropriate amount of residual.
As stated earlier, banks and surety underwriters are evaluating the strength of a company’s financial statement. Oftentimes, the net book value of equipment is one of the larger dollar values posted on the contractor’s balance sheet. By reflecting a salvage value, we increase the reporting of total assets. Book depreciation expense is reduced, allowing a contractor to show a larger balance in retained earnings. Net capital accounts are closely monitored and are often used in many bank covenants, surety programs, and state bidding qualifications.
We can’t leave the world of fixed assets without a discussion on repairs and maintenance. Before accelerated depreciation rules came into existence, analyzing repairs to determine if they extended the useful life of an asset had much more priority. Despite all of the tax law nuances, repairs and maintenance calculations and classifications are still important to the contractor. An easy example of why is readily evident when a contractor endures a New Jersey Sales Tax audit. Any contractor who has undergone this audit can appreciate the need to be diligent.
Too often, repairs and maintenance are not reclassified to fixed assets when they truly extend the useful life. And too often, those repairs and maintenance invoices do not reflect the proper amount of sales tax charged. This creates a use tax liability, which is not an immaterial amount of dollars. Invoices should be scrutinized for tax charged on materials and labor, if not extending the equipment’s useful life. Additionally, some specialty equipment used in a manufacturing operation for cement or asphalt production has its own considerations and benefits.
Lastly, we remind clients to understand listed property rules for vehicles under 6,000 pounds and trucks with gross vehicle weight over 26,000 pounds. Both items roll with unique rules that, if not identified and managed in a timely manner, can create hidden tax burdens or the loss of some tax saving benefits to the contractor.
For assistance with these and other important accounting issues for contractors, contact the Curchin Group.