How to Book a Depreciation Expense Journal Entry
Understand how to account for asset depreciation, record its expense, and reflect its impact on your financial statements.
Depreciation is an accounting process that systematically allocates the cost of a tangible asset over its useful life. This method reflects the gradual decrease in an asset’s value due to wear, obsolescence, or usage. Businesses account for depreciation to accurately reflect an asset’s true value and profitability across accounting periods.
Key Concepts of Depreciation
Depreciation is a non-cash expense that spreads the upfront cost of a physical asset over its productive life. This accounting practice aligns the expense of using an asset with the revenue it helps generate, adhering to the matching principle. It provides a more accurate representation of a company’s financial performance and the declining value of its assets.
Depreciable assets are typically tangible, such as machinery, equipment, vehicles, buildings, and furniture. For an asset to be depreciated, it must be owned by the business, used in business or income-producing activities, have a determinable useful life, and be expected to last for more than one year. Assets not subject to depreciation include land, which has an unlimited useful life, and intangible assets like patents or copyrights, which are typically amortized. Inventory and investments like stocks or bonds are also not depreciated.
Methods for Calculating Depreciation
The straight-line method is the most common and straightforward way to calculate depreciation, spreading the cost evenly over an asset’s useful life. The formula for this method is: (Cost – Salvage Value) / Useful Life. For example, if equipment costs $50,000, has a 5-year useful life, and a $5,000 salvage value (the amount it can be sold for at the end of its useful life), the annual depreciation would be ($50,000 – $5,000) / 5 years = $9,000 per year. The asset’s cost includes the purchase price and any expenses incurred to get it ready for use, such as shipping or installation.
Other methods also exist for calculating depreciation. The declining balance method, including the double-declining balance method, is an accelerated approach that records larger depreciation expenses in earlier years. This method is often chosen for assets that lose value more quickly in their initial period of use. The units of production method, conversely, allocates depreciation based on an asset’s actual usage or output. This means expense can vary from year to year depending on utilization.
Recording Depreciation Entries
Once the depreciation amount is calculated, recording it involves a specific journal entry. The entry requires a debit to Depreciation Expense and a credit to Accumulated Depreciation. This entry is typically made at the end of an accounting period, such as monthly, quarterly, or annually.
Depreciation Expense is an account on the income statement, reflecting the asset’s cost allocated to the current period. Accumulated Depreciation is a contra-asset account on the balance sheet, reducing the reported value of the related fixed asset. This account represents the total depreciation recognized for an asset since acquisition. For instance, using the previous example’s annual depreciation of $9,000, the journal entry is: Debit Depreciation Expense $9,000, Credit Accumulated Depreciation $9,000.
Financial Statement Presentation
Depreciation impacts a company’s financial statements by influencing both profitability and asset valuation. On the income statement, Depreciation Expense is reported as an operating expense, which reduces the company’s net income. This reflects the cost of using the asset to generate revenue.
On the balance sheet, Accumulated Depreciation is presented directly below the corresponding fixed asset. It acts as a deduction from the asset’s original cost, resulting in the asset’s “net book value” or “carrying value” (Asset Cost – Accumulated Depreciation). While depreciation is a non-cash expense, it is added back to net income in the operating activities section of the cash flow statement when using the indirect method. This adjustment occurs because depreciation reduces net income without consuming cash.