How to Show Depreciation on a Balance Sheet

Depreciation is a fundamental accounting concept impacting how businesses present financial health. It systematically allocates long-term asset costs over their useful lives. This influences a company’s reported asset value and profitability, reflecting asset’s economic benefit consumption.

Fundamentals of Depreciation

Depreciation systematically allocates a tangible asset’s cost over its expected period of use. It spreads initial asset costs like buildings or machinery across the accounting periods they benefit. This aligns the asset’s cost with the revenues it helps generate, adhering to the matching principle of accrual accounting, ensuring expenses are recognized in the same period as related revenues.

An asset’s “useful life” is the estimated period a business expects to benefit from its use, based on factors like wear and tear or obsolescence. “Salvage value,” or residual value, is the estimated amount a company anticipates receiving from selling an asset at the end of its useful life. For federal income tax purposes, the IRS provides guidelines under the Modified Accelerated Cost Recovery System (MACRS) in Publication 946. MACRS generally does not consider salvage value for depreciation.

Balance Sheet Asset Presentation

A balance sheet provides a snapshot of a company’s financial position. Assets are organized by liquidity, with current assets like cash and accounts receivable listed first. Long-term assets, such as property, plant, and equipment (PP&E), follow, presented last due to their long-term nature and lower liquidity.

Long-term assets are initially recorded at historical cost, including purchase price and all costs to prepare the asset for its intended use. The original cost remains on the balance sheet as a record of initial investment. Its reported value is adjusted over time to reflect consumption. The “net book value” or “carrying amount” is this adjusted figure, representing the asset’s original cost less accumulated depreciation.

Recording Accumulated Depreciation

Accumulated depreciation is a contra-asset account reducing the reported balance of a related asset. Unlike typical asset accounts with a debit balance, it normally carries a credit balance. This account systematically gathers all depreciation expense recognized for an asset from its acquisition, showing the total portion of its cost expensed over its service life.

On the balance sheet, accumulated depreciation is presented directly underneath the related asset, as a deduction from its original cost. For instance, if machinery cost $100,000 and accumulated $30,000 in depreciation, it is presented as: Machinery (at cost) $100,000, Less: Accumulated Depreciation $30,000. The net book value, or carrying value, is calculated as original cost minus accumulated depreciation, resulting in $70,000.

This presentation illustrates how an asset’s value is systematically reduced over its useful life, providing transparency on its original investment and expensed cost. The accumulated depreciation account increases each period as more depreciation is recognized, growing until the asset is fully depreciated or disposed of. A fully depreciated asset’s net book value equals its salvage value, or zero if no salvage value was assumed. For tax reporting, businesses use IRS Form 4562 to report depreciation.

Illustrative Example

To illustrate how a fixed asset and its accumulated depreciation appear on a balance sheet, consider this simplified example. It clarifies concepts, showing original cost, total depreciation, and resulting current value.

Balance Sheet Excerpt (Partial)

Property, Plant, and Equipment
Equipment (at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $75,000
Less: Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,000)
Net Book Value of Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000

The “Equipment (at cost)” line shows the original historical cost of $75,000. “Less: Accumulated Depreciation” indicates $25,000 has been expensed. The “Net Book Value of Equipment” of $50,000 is the carrying amount, calculated as original cost minus accumulated depreciation.

References

Internal Revenue Service. Publication 946, How To Depreciate Property. Internal Revenue Service. Form 4562, Depreciation and Amortization.