Depreciation Expense

A depreciation expense is required due to the reduction in value of a long term asset caused by its limited useful life.

Most long term assets (with the exception of land) have a limited useful life as a result of wear and tear and obsolescence and therefore depreciate over time.

Wear and tear or physical deterioration results from use. The asset can be kept in good working order by regular repairs and maintenance but ultimately it will have to be discarded and replaced.

Obsolescence is a consequence of changing technology. An asset such as a computer may not have worn out but may have gone out of date and need replacing due to technological changes.

In accounting, the depreciation expense is the allocation of the cost of the asset to the accounting periods over which it is to be used. The allocation is necessary to comply with the matching principle, ensuring that the expense of owning the asset is matched to the revenues generated by the asset.

An estimate of this depreciation expense is charged to the income statement each accounting period and represents an expense of the business.

How to Calculate the Depreciation Expense

If for example, a business has purchased furniture with a value of 4,000 and expects it to have a useful life of 4 years and no salvage value, then the straight line depreciation expense would be calculated as follows:

Depreciation expense = (Cost of fixed asset - Salvage value) / Useful life
Depreciation expense = (4,000 - 0) / 4 = 1,000

In this example the depreciable value is 4,000 and the depreciation expense is 1,000 per year for the next 4 years.

Partial Year Depreciation Expense

The example above assumes that the business purchased the asset at the beginning of the accounting period and a full years depreciation expense (1,000) is calculated. If the business acquires the asset part way through the year it has two options:

  1. Decide on a specific depreciation accounting policy, such as a full years depreciation expense will be charged in the year of acquisition.
  2. or,

  3. Pro rata the depreciation expense for the first year depending on the number of months the equipment was in use. Using the example above, suppose the equipment was acquired at the start of month 3, then it would have been in use for 9 months of the year, and the depreciation expense for the first year is calculated as 1,000 x 9/12 = 750.

In both cases the depreciation expense method should be applied consistently each accounting period.

Methods of Depreciation

There are various methods used to calculate depreciation, but they generally fall into two categories.

Straight Line Method

The straight line method depreciates the asset at a constant rate over its useful life. The depreciation charge will be the same for each accounting period. Further details on using the method can be found in our straight line depreciation tutorial.

Accelerated Depreciation Methods

The accelerated depreciation method as the name implies, will accelerate the charge for depreciation by making the charge in the early years higher than the charge in the later years. There are various ways in which accelerated depreciation can be calculated including, declining balance, double declining balance, and sum of digits methods.

Depreciation Expense Journal Entry

The depreciation expense is calculated at the end of an accounting period and is entered as a journal

Depreciation Expense
Account Debit Credit
Depreciation Expense 1,000
Accumulated Depreciation 1,000
Total 1,000 1,000

The first entry is the expense being recorded in the income statement, the second entry is to the accumulated depreciation account which is a contra asset account in the balance sheet.

The accumulated depreciation account is used as it reflects only an estimate of how much the asset has been used during the accounting period, and the asset account itself continues to show the original cost of the asset.

It is normal to group long term (fixed) assets into categories which have the same useful life (e.g. computer equipment might have a 3 year useful life) so that depreciation can be more easily calculated and recorded in the accounting records.

It is important to understand that although the charging of depreciation affects the net income (and therefore the amount equity attributable to shareholders) of a business, it does not involve the movement of cash.

Depreciation Expense September 20th, 2017Team

You May Also Like

Related pages

debit prepaid expensedouble entry bookkepingaccounting for allowance for doubtful accountsmicrosoft excel balance sheet templateadjusting entry for supplies usedpremium on bond payableexamples of t accounts debits and creditsformula for cash conversion cycledouble entry cash book formatpv of an annuity calculatorear financial calculatorhow to calculate annuity in excelhow to calculate stock value in excelis bonds payable a current liabilitycash flow to creditorwho is consignor and consigneewhat is a suspense paymentinventory accounting basicspercentage complete formula excelcalculating asset turnover ratiorequisition slip samplehow to calculate fifo and lifodebt service calculator excelentries for direct labor and factory overheadwhat is straight line amortizationadjusting entries worksheet examplesaccounting aptitude test questions and answersretained earnings debit balanceaccounting verifiabilityfv of annuity formulafixed asset turnover ratio calculatordouble declining method depreciationeffective monthly interest rate calculatorprepaid journal entriesquick ratio calculation formulapresent value of growing perpetuitycalculate vertical analysisdays sales in receivables calculatortrial balance of totalsmargin or markupreverse stock split examplerecording notes payablemargin and markupcapital turnoverperpetuity modeltrading days calculatortrade discount accountingdebtors control accountpetty cash expense report templatereturns outwardsmeaning of retained earningrestaurant accounting chart of accountsmethods of bank reconciliation statementaccounting journal and ledgerpetty cash entriesfixed asset turnover industry averagecash flow statement analysis examplesum of years digits calculatorperpetuity example problemdirect materials used formulacoupon bond exampleselling goods on consignmentformula to calculate gross profit marginincome statement and balance sheet templatefactory overheadscapital lease amortizationpmt rate nper pv fv 0 type 0adjusted and unadjusted trial balancegross margin equationpaid creditor on account journal entrymileage claim form templateunearned interesthow to calculate variable manufacturing overheadaccrual adjusting entries examplesprepaid insurance income statementformula for total asset turnover ratiojurnal account payabledividends declared journal entrybookkeeping spreadsheet