Chapter 9 — Inventory, Equipment, and Depreciation

Chapter 9 — Inventory, Equipment, and Depreciation

Some of what a business buys gets used up right away — cleaning supplies, printer paper, fuel. Some of it sticks around: the products on the shelves, the delivery van, the ovens, the computers. This chapter covers the “sticks around” category — how to track it, when it becomes an expense, and the tax rules that let you deduct big purchases faster.

Tracking inventory

If you sell physical products, inventory is probably one of your largest assets — and one of the easiest to get wrong. There are two systems for tracking it.

Periodic inventory means counting everything at set intervals and calculating what you sold from the count: Beginning Inventory + Purchases − Ending Inventory = Cost of Goods Sold. Example: a hardware store starts January with $40,000 of inventory, buys $25,000 more, and counts $38,000 at month-end. COGS = $40,000 + $25,000 − $38,000 = $27,000. That $27,000 flows to the profit & loss statement; the $38,000 remaining stays on the balance sheet. The blind spot: between counts you don’t know your exact level, and shrinkage (theft, damage, spoilage) shows up only as mysteriously high COGS.

Perpetual inventory means recording every purchase and every sale in real time — usually via point-of-sale or inventory software — so the system always shows what’s on hand. More work to maintain, but you get live numbers: reorder alerts, per-product margins, and shrinkage you can spot because the system count and the physical count should agree.

Two disciplines that matter: count on schedule, not when you feel like it — the count is what makes the COGS formula honest. And value inventory at cost: the $38,000 on the shelves is what you paid for it, not what you’ll sell it for. The profit comes when it sells — not before.

Fixed assets: capitalize, don’t expense

A fixed asset is something the business buys to use for more than a year: vehicles, machinery, computers, furniture, buildings. The rule: capitalize it — record it as an asset on the balance sheet, not as an immediate expense. The $30,000 delivery van will help earn revenue for years, so its cost should be spread across those years under the matching principle, not dumped into the month you bought it.

The dividing line between “supplies” (expense now) and “equipment” (capitalize) is your capitalization policy — a threshold you set, commonly $2,500 for small businesses (which also aligns with the IRS de minimis safe harbor for businesses without audited financial statements). Pick a threshold, write it down, and apply it consistently.

Depreciation basics

Depreciation spreads a capitalized asset’s cost across its useful life. The simplest method — and the one most small businesses use for their books — is straight-line: divide the cost evenly over the useful life. A $30,000 van with a 5-year life depreciates $6,000 per year.

The mechanics use accumulated depreciation — a contra-asset account against the asset on the balance sheet. The van stays on the books at its $30,000 cost, accumulated depreciation grows by $6,000 a year, and the book value (cost minus accumulated depreciation) declines: $24,000 after year one, $18,000 after year two.

One distinction matters: depreciation for your books (straight-line, your chosen useful life) and depreciation for taxes follow different rulebooks. Tax depreciation uses IRS recovery periods and methods (MACRS) — and, crucially, the tax code sometimes lets you deduct the entire cost immediately. That’s Section 179 and bonus depreciation.

Section 179 and bonus depreciation: deducting it now

Section 179 expensing lets a business deduct the full cost of qualifying equipment (machinery, vehicles, computers, off-the-shelf software, and certain improvements) in the year it’s placed in service. For 2026, the limit is approximately $2.56 million of purchases, and the benefit begins phasing out once total qualifying purchases exceed approximately $4.09 million (both inflation-adjusted under the One Big Beautiful Bill Act). In plain terms: all but the very largest businesses can expense their equipment purchases in full.

Bonus depreciation allows a percentage of the cost of qualifying new or used property to be deducted immediately. Under the One Big Beautiful Bill Act, bonus depreciation is 100% — and permanent — for qualified property acquired after January 19, 2025. Buy a $50,000 piece of qualifying equipment in 2026, and you can generally deduct the full $50,000 that year.

Practical notes: both provisions apply to the tax return, not necessarily your books — many businesses keep straight-line depreciation on the books and take the accelerated deduction on the return. “Placed in service” matters more than “paid for” — equipment deducted in 2026 generally must be bought and put to use in 2026. These are timing tools, not extra deductions, and they can swing taxable income dramatically — so discuss large purchases with your CPA before year-end, not after. Confirm current law before planning a major purchase.

The asset lifecycle and the repairs-vs.-improvements line

Every long-lived purchase follows the same path: buy (debit the fixed asset account, credit Cash or Loan Payable); use (each period, debit Depreciation Expense, credit Accumulated Depreciation — or your CPA applies Section 179 or bonus depreciation on the return); dispose (remove cost and accumulated depreciation, record any gain or loss — a van with a $6,000 book value sold for $9,000 produces a $3,000 gain, which is taxable income). Maintain a simple fixed asset register — every asset with purchase date, cost, useful life, and accumulated depreciation. Your CPA will thank you at tax time.

The repairs-vs.-improvements judgment call: fixing the van’s brakes for $900 restores it — expense it. Installing a $4,000 refrigeration unit extends its capabilities and useful life — capitalize and depreciate it. The IRS test: did the spending make the asset better, bigger, or longer-lived, or merely restore it? A de minimis safe harbor generally lets businesses expense items under $2,500 — confirm treatment with your CPA for large expenditures.

Key takeaways

• Track inventory with Beginning Inventory + Purchases − Ending Inventory = COGS; count physically on schedule and value inventory at cost.
• Capitalize long-lived purchases as assets (set a written capitalization threshold, commonly $2,500); spread the cost via depreciation under the matching principle.
• Straight-line depreciation with an accumulated depreciation contra-account keeps original cost visible while book value declines.
• Section 179 for 2026: deduct up to ~$2.56M of qualifying equipment, phasing out above ~$4.09M in total purchases (inflation-adjusted under the One Big Beautiful Bill Act).
• Bonus depreciation is 100% and permanent for qualified property acquired after January 19, 2025.
• Accelerated deductions apply on the tax return; discuss large purchases with your CPA before year-end.
• Keep a fixed asset register; record gains or losses when assets are sold or disposed of.