Journal Entry For Depreciation
Depreciation Journal Entry is the journal entry passed to record the reduction in the value of the fixed assets due to normal wear and tear, normal usage or technological changes, etc. where depreciation account will be debited and the respective fixed asset account will be credited. The main objective of a journal entry for depreciation expense is to abide by the matching principle.
The journal entry for depreciation refers to a debit entry to the depreciation expense account in the income statement and a credit journal entry to the accumulated depreciation account in the balance sheet. In each accounting period, a predetermined portion of the capitalized costCapitalized CostCapitalization cost is an expense to acquire an asset that the company will use for their business; such costs are recorded in the company's balance sheet at the year-end. These costs are not deducted from the revenue but are depreciated or amortized over time. of existing fixed assets, such as equipment, building, vehicle, etc., is transferred from the fixed assets in the balance sheet to depreciation expense in the income statement so that the cost can be matched with the corresponding revenue generated by utilizing these assets.
- The “Accumulated Depreciation” account is captured under the asset heading of Property Plant and Equipment (PP&E ). This account is also referred to as a contra asset accountA Contra Asset AccountA contra asset account is an asset account with a credit balance related to one of the assets with a debit balance. When we add the balances of these two assets, we will get the net book value or carrying value of the assets having a debit balance. since it is an asset account with a credit balance. Given that the accumulated depreciation accountAccumulated Depreciation AccountThe accumulated depreciation of an asset is the amount of cumulative depreciation charged on the asset from its purchase date until the reporting date. It is a contra-account, the difference between the asset's purchase price and its carrying value on the balance sheet. is a part of the balance sheet, its outstanding balance amount is carried over to the next accounting period. The credit balanceCredit BalanceCredit Balance is the capital amount that a company owes to its customers & it is reflected on the right side of the General Ledger Account. Usually, Liability accounts, Revenue accounts, Equity Accounts, Contra-Expense & Contra-Asset accounts tend to have the credit balance. of the accumulated depreciation account eventually becomes as large as the cost of the assets that are being depreciated.
- The “Depreciation Expense” account is a part of the income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements., and it is a temporary account. At the end of each accounting period, the balance from the depreciation expense account is moved to the accumulated depreciation account, and the depreciation expense account will eventually begin the new accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance. with a zero balance.
Examples of Depreciation Expense Journal Entry
Let us consider the example of a company called XYZ Ltd that bought a cake baking oven at the beginning of the year on January 1, 2018, and the oven is worth $15,000. The owner of the company estimates that the useful life of this oven is about ten years, and probably it won’t be worth anything after those ten years. Show how the journal entry for the depreciation expense will be recorded at the end of the accounting period on December 31, 2018.
Let us assume that the depreciation will be charged on the straight-line methodStraight-line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. ; then the annual depreciation charge can be calculated as,
Annual depreciation expense = (Cost of the asset – Salvage value of the assetSalvage Value Of The AssetSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company's machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000.) / Useful life
Therefore, the journal entry for the depreciation expense is as shown below,
Depreciation Journal Entry
|December 31, 2018||Depreciation Expense Account||$1,500|
|Accumulated Depreciation Account||$1,500|
|To record depreciation expense on the newly purchased cake baking oven)|
Let us take the example of a company to calculate the depreciation expense during the year and illustrate the journal entry of the depreciation expense in the financial statements. The following facts are available:
- On January 1, 2018, the company bought a piece of equipment worth $6,000
- The equipment is estimated to have a useful life of 3 years
- The equipment is not expected to have any salvage value at the end of its useful life
- The company intends to follow the straight-line method of depreciation over the 3 years life.
Since the company will use the equipment for the next three years, the cost of the equipment can be spread across the next three years. The annual depreciation for the equipmentDepreciation For The EquipmentDepreciation on Equipment refers to the decremented value of an equipment's cost after deducting salvage value over the life of an equipment. It lowers its resale value. as per the straight-line method can be calculated,
Annual depreciation = $6,000 / 3 = $2,000 a year over the next 3 years.
Therefore, it will be recorded according to the golden rule of accounting-
- Debit depreciation expense account and
- Credit accumulated depreciation account
Let us assume that the company prepares annual financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. only, and the depreciation journal entries can be prepared for the fiscal years (from 2016 to 2018) as of the last day of each year.
|December 31, 2016||Depreciation Expense Account||$2,000|
|Accumulated Depreciation Account||$2,000|
|December 31, 2017||Depreciation Expense Account||$2,000|
|Accumulated Depreciation Account||$2,000|
|December 31, 2018||Depreciation Expense Account||$2,000|
|Accumulated Depreciation Account||$2,000|
Relevance and Uses
From the view of accounting, accumulated depreciation is an important aspect as it is relevant for assets that are capitalized. It is very important to understand that when a depreciation expense journal entry is recognized in the financial statements, then the net income of the concerned company is decreased by the same amount. However, the cash reserve of the company is not impacted by the recording as depreciation is a non-cash item. The cash balance would have been reduced at the time of acquisition of the asset.
Another important aspect of depreciation is that it is an estimate based on the historical cost of the asset (not the replacement costThe Replacement CostReplacement Cost is the capital amount required to replace the current asset with a similar one at the present market rate. Usually, assets replacement occurs when their repair & maintenance charges surge beyond a reasonable level. ), its expected useful life, and its probable salvage value at the time of disposal. There is a common misconception that depreciation is a method of expensing a capitalized asset over a while.
Nevertheless, the process of depreciation is a way of evaluating the capitalized asset over a period of time due to normal usage, wear, and tear new technology or unfavorable market conditions. Depreciation expense account and accumulated depreciation account help in the estimation of the current value or the book value of an assetBook Value Of An AssetBook Value of Assets is the asset's value in the books of records of a company or an institution at any given instance. Assets Book Value Formula = Total Value of an Asset – Depreciation – Other Expenses Directly Related to it . However, there might be instances when the market value of a one-year-old computer may be less than the outstanding amount recognized in the balance sheet. On the other hand, a rental property that is located in a growing area may end up having a market value that is greater than the outstanding amount recognized in the balance sheet. It happens because of the difference in the depreciation method adopted by the market and the company.
This article has been a guide to Depreciation Journal Entry. Here we discuss the journal entries of Depreciation expense along with the practical example and its uses. You can learn more about from the Accounting following articles –