Expertise Lies Between the Lines

Unfortunately, despite its financial and legal implications, many individuals tend to overlook this aspect. This article will delve into the importance of recognizing the value of depreciation in the income statement and its potential consequences if not given full consideration. We will use an illustration from Ziad Rayess' book "Shortcut for a Better Life" to show the possible issues that may arise from ignoring this crucial accounting topic.

The Importance of Proper Depreciation Accounting in Business Management:

In his book "Shortcut for a Better Life", the writer "Ziad Rayess" mentions: I received a consultation from the management of a company regarding depreciation of company assets (buildings, tools, equipment, vehicles, furniture) and the amount that should be allocated in the financial statement in the income statement for this purpose.

This example is important because I want to highlight the fact that many people don’t care about this topic, even though it has financial and legal implications. Neglecting to give this item full consideration can result in the following:

1. Not recognizing the value of depreciation in the income statement can give the appearance of additional value from imaginary net profits. These are then used to distribute shares between management and the capital owner. Many companies allocate a proportion of net profits to management and another to capital. Years can go by with incorrect distributions happening like this.
2. Adding the depreciation value to the net profit adds some imaginary profits, which makes it more attractive for partners to pump more capital into the company based off incorrect reports.
3. In the years to come, some partners might leave based on the entirely incorrect data, and their exit may not be fair.
4. With time, the problem will be compounded, and the truth and implications will become apparent when the capital—or a large part of it—disappears. Legitimate disputes between members will boil over, not because of a lack of trust or the values themselves, but because there was no information, standards were not upheld, and there were no professional financial statements.

The example above is a sample of the issues that can strongly create significant and painful business disputes between partners. The disputes can’t be explained by bad intentions, nor by one partner having an agenda. It all goes back to a lack of real professional experience.

This is applicable to many accounting topics that need to be periodically checked. It doesn’t take much time to deal with, but it has repercussions you’ll have to deal with later. Workers ignore it and spend in cash from the beginning, including dividends, without realizing how much debt is piling up, in some cases more than the value of the company’s shares if it’s liquidated.

For example, staff end-of-service bonuses, (which compound over the years), often fall victim to this mistake. Ditto for tax payments to the government, etc.

So it’s important to keep up with internal and external financial auditing in accordance with the most recent local and international laws and standards.

Conclusion:

Considering that depreciation can have significant financial and legal ramifications, it is crucial to account for its value in the income statement. Overlooking this topic can result in a variety of issues, including incorrect distributions of shares and imaginary profits, leading to business disputes between partners. It is crucial to periodically check various accounting topics, including the depreciation of company assets, to ensure compliance with local and international laws and standards. Failure to do so can have repercussions that aren't always obvious but eventually add up to serious consequences. Thus, it is vital to give due consideration to these financial matters to avoid any future issues.