Recoring Depreciation
Depreciation is a process of allocating capital expenditure over useful life of an asset and recorded as an expense to profit and loss for the period. On the other hand, the cost value of asset is reduced by the same amount from balance sheet.
Accumulated Depreciation Account
It is important to understand that depreciation is a provision in its essence, an unrealized and noncash expense. The actual cash flow occurs when the asset is purchased or sold. The allocation of cost of the asset over its useful life in the form of depreciation is done in order to fulfill the requirements of matching principle of accounting.
Further, this reduction in the value of asset is due to the allocation of the capital expenditure over its useful life and not an actual decrease in the value of an asset.
Therefore, instead of directly reducing the value of the asset, the deprecation charged each year is recorded in a separate provision for depreciation account (also called as accumulated depreciation account).
Accounting Entries for Depreciation
The above stated narration can be translated in the form of accounting entries as provided below:
Dr. Depreciation Expense XXX
Cr. Accumulated Depreciation XXX
The above paragraphs and accounting entry implicit that we have two ledger accounts for an asset, one carrying the cost/ capital expenditure incurred and the other having the record of depreciation charged on account of that asset till date.
These two ledger accounts mentioned above i.e. Asset Account (carrying Cost/ value of an asset) and accumulated depreciation account are maintained separately in Books of accounts. Besides, the two accounts are net off while presenting in the Statement of Financial Position/ Balance sheet.
Example: –
Mr. Kim bought a truck for Business use for $ 40,000 including all the duties and taxes, however paid a mandatory insurance premium of $5,000 valid for the next 10 years. The estimated useful life of the truck is 10 year and the estimated salvage value after 10 years is $ $5,000.
Assuming the straight-line method of depreciation, Mr. Kim will charge the following amount of depreciation each year.
Depreciation expense= Depreciable Value ÷ Useful life
Where,
Depreciable Value= Cost of Asset + any expense paid to bring the asset for its intended use less salvage value after its useful life.
So, the Depreciation expense for each year for next 10 years on account of this truck will be: –
Depreciation Expense= ($40,000+ $5,000 -$5,000) ÷10=$4,000
Stages in Recording Depreciation
The Accounting entries for recording Asset in the time of purchase of Asset and subsequent year end entries will be as follows;
· To record the purchase of Asset at the beginning
Dr. Truck (Asset) Account $45,000
Cr. Cash (for purchase cost of Asset) $40,000
Cr. Cash (for Mandatory insurance to operate the asset) $5,000
· To record depreciation Expense at year end
Dr. Depreciation Expense $4,000
Cr. Accumulated Depreciation Account $4,000
· The extract of Balance Sheet at year End will be as follows:
Asset at Cost $45,000
Less: Accumulated depreciation ($4,000)
Carrying value of the Asset at the end of Year 1 $ 41,000
The below provided table shows how the depreciation expense charges each year will be accumulated and will be disclosed in Balance sheet each year.
| Time | Depreciation Expense(A) | Balance of Accumulated Depreciation (B=Last year + A) | Asset at Cost (C) | Carrying Value of Asset in Balance Sheet(D=C-B) |
| At the Beginning | 0 | 0 | $45,000 | $45,000 |
| At the end of Year1 | $4,000 | $4,000 | $45,000 | $41,000 |
| At the end of Year2 | $4,000 | $8,000 | $45,000 | $37,000 |
| At the end of Year3 | $4,000 | $12,000 | $45,000 | $33,000 |
| At the end of Year4 | $4,000 | $16,000 | $45,000 | $29,000 |
| At the end of Year5 | $4,000 | $20,000 | $45,000 | $25,000 |
| At the end of Year6 | $4,000 | $24,000 | $45,000 | $21,000 |
| At the end of Year7 | $4,000 | $28,000 | $45,000 | $17,000 |
| At the end of Year8 | $4,000 | $32,000 | $45,000 | $13,000 |
| At the end of Year9 | $4,000 | $36,000 | $45,000 | $9,000 |
| At the end of Year10 | $4,000 | $40,000 | $45,000 | $5,000 |
From the above table we can see that all the depreciable value of the asset has been allocated/ depreciated over the useful life and the carrying value after 10 years is equal to salvage value estimated at the beginning.
