Depreciation Expense Journal Entry: Accounts, Methods, and Recording Steps
Learn how to accurately record depreciation expenses, choose appropriate methods, and understand the accounts involved for clear and compliant financial reporting.
Businesses owning long-term assets like equipment or buildings must account for their gradual loss of value through a process called depreciation. Recording depreciation ensures financial statements accurately reflect an asset’s worth and the company’s profitability over time.
Properly handling depreciation via journal entries keeps financial records accurate and compliant with accounting standards, supporting informed business decisions.
Purpose of This Journal Entry
The depreciation expense journal entry systematically allocates the cost of a tangible asset over its estimated useful life. This accounting method spreads the asset’s purchase cost across the periods it helps generate revenue, rather than tracking fluctuations in market value. This practice adheres to the matching principle in accrual accounting.
The matching principle requires expenses to be recognized in the same period as the revenues they help produce. Since long-term assets contribute to revenue over many years, charging their full cost upon purchase would distort financial results, understating profit initially and overstating it later. Depreciation aligns a portion of the asset’s cost with the revenues earned each period, offering a clearer picture of profitability.
This systematic allocation is required by major accounting frameworks like Generally Accepted Accounting Principles (GAAP) in the United States and International Financial Reporting Standards (IFRS).1ACCA Global. Property, Plant and Equipment These standards ensure financial statements consistently and comparably reflect a company’s financial position and performance.
Accounts Involved in Depreciation
Recording depreciation uses two main accounts: Depreciation Expense and Accumulated Depreciation.
Depreciation Expense is an income statement account representing the portion of an asset’s cost allocated to a specific period. It functions as an operating expense, reducing the company’s net income for that period. Although it lowers profit, depreciation is a non-cash expense, meaning no actual cash outflow occurs when it is recorded.
Accumulated Depreciation is a balance sheet account, specifically a contra-asset account. Contra-asset accounts have credit balances, reducing the value of related assets which normally have debit balances. This account tracks the total depreciation recorded for an asset since it was acquired, reducing the asset’s carrying value on the balance sheet without altering its original cost record.
On the balance sheet, the asset’s original cost is shown, less the accumulated depreciation, resulting in the net book value (or carrying value). For instance, equipment bought for $50,000 with $10,000 in accumulated depreciation has a net book value of $40,000. This presentation provides transparency about the asset’s remaining undepreciated cost. The balance in Accumulated Depreciation grows over time until the asset is fully depreciated or disposed of.
Common Depreciation Methods
Companies can choose from several depreciation methods allowed under GAAP and IFRS, selecting one that rationally reflects how the asset’s economic benefits are consumed. The chosen method should be applied consistently but reviewed periodically.
Straight-Line
The straight-line method allocates depreciation evenly over the asset’s useful life. It is calculated by subtracting the asset’s estimated salvage value (residual value at disposal) from its cost, then dividing by its useful life. If a machine costs $50,000, has a $5,000 salvage value, and a 10-year life, annual depreciation is ($50,000 – $5,000) / 10 = $4,500. Its simplicity makes it widely used.
Declining Balance
The declining balance method is an accelerated approach, recording higher depreciation in early years and lower amounts later. This often aligns with assets being more productive when new. It involves applying a fixed rate to the asset’s book value (cost minus accumulated depreciation) each period. A common variant, double-declining balance, uses twice the straight-line rate. Depreciation ceases when the book value reaches the salvage value.
Units of Production
This method bases depreciation on the asset’s actual usage or output, suitable for assets where wear relates directly to use (e.g., machinery hours, vehicle miles). A per-unit depreciation rate is calculated: (Cost – Salvage Value) / Total Estimated Production Capacity. This rate is multiplied by the actual units produced or used during the period to determine the depreciation expense. For example, a machine costing $60,000 with a $10,000 salvage value, expected to produce 100,000 units, has a rate of $0.50 per unit. If it produces 15,000 units in a year, depreciation is $7,500 ($0.50 15,000).
How to Record the Entry
Recording depreciation requires a journal entry based on double-entry bookkeeping, where total debits equal total credits. This entry is typically made as an adjusting entry at the end of an accounting period (monthly, quarterly, or annually) before preparing financial statements.
The standard journal entry involves debiting the Depreciation Expense account. This increases the expense balance on the income statement for the period.
Simultaneously, the Accumulated Depreciation account is credited. This increases the balance of this contra-asset account on the balance sheet, reducing the asset’s net book value.
For example, if annual depreciation is calculated as $4,500, the entry is:
Debit: Depreciation Expense $4,500
Credit: Accumulated Depreciation $4,500
This process repeats each period. The Depreciation Expense affects only the current period’s income statement, while the Accumulated Depreciation balance grows over the asset’s life on the balance sheet. This ensures the asset’s cost is systematically allocated and financial statements adhere to accounting standards. When an asset is sold or retired, both its original cost and total accumulated depreciation are removed from the accounts.