Accounting Entry for Depreciation – Meaning, Examples, & How to Calculate It

Introduction

Fixed assets are an important component for any growing business, as they have long-term value and help generate income over time. The accounting treatment for these assets, however, can be slightly confusing. Physical assets are subject to depreciation to accurately ascertain their effect on the expenses and the revenue generated by a company.

In this blog, we are going to talk about the accounting entry for depreciation, how to calculate depreciation expense, and how to record a depreciation journal entry.

What is Depreciation in Accounting?

Depreciation in accounting refers to the practice of spreading the cost of an asset over a period of time until its complete book value has been realized. Physical assets like vehicles, buildings, and equipment are depreciated on the balance sheet and expensed on the income statement at the end of every accounting period. 

Businesses have to depreciate their tangible assets on financial statements to comply with accounting standards such as the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Since fixed assets are purchased at a lump sum initially, they have to be expensed on the income statement over time to reflect the accurate financial position of the company. 

What is Accounting Entry for Depreciation?

Journal entry for depreciation records the reduced value of a tangible asset, such a office building, vehicle, or equipment, to show the use of the asset over time. In a depreciation journal entry, the depreciation account is debited and the fixed asset account is credited. 

A depreciation journal entry helps companies follow the matching principle and, in turn, accurately present their financial health to stakeholders. The cost of the asset is expensed on the income statement and depreciated on the balance sheet. The process continues until the asset is fully used or sold. 

Types of Journal Entries for Depreciation

Now that we’ve discussed what depreciation and depreciation journal entries are, let’s talk about the types of depreciation journal entries. There are different types of journal entry methods that businesses can use. The process for recording journal entries for all types remains the same; however, the journal entry totals will differ according to the depreciation method a company uses. 

Here are the four depreciation journal entry methods that are used most commonly by businesses:

1. Straight line depreciation: One of the easiest ways to calculate depreciation is through the straight line depreciation method, as it keeps the depreciation amount the same for each year. This depreciation method is usually used for assets that lose their value steadily over time. 
2. Double declining depreciation:Double declining depreciation is a type of accelerated depreciation method and is ideally used for assets that lose their value quickly in the initial years. Using this method allows companies to better match the expense with the income generated through the asset. 
3. Units of production depreciation: This depreciation method takes into account the number of units an asset can produce during its lifetime. The units of production depreciation method is useful for assets such as equipment and machinery whose usefulness is determined by the anticipated number of units they can produce. 
4. Sum-of-the-years depreciation: Sum-of-years depreciation is another kind of accelerated depreciation method and considers the total number of years an asset is expected to last. This depreciation method is also suited for assets that lose their value quickly in the initial years of their useful life. 

How to Calculate the Depreciation Expense Journal Entry

When a tangible asset is purchased, it is recorded at its historical cost, and then a depreciation entry is recorded at the end of each accounting period to adjust the cost of the asset until it is fully used. 

Before we get to the actual calculation method for each of the depreciation methods, there are a few things a business must be aware of:

1. Cost: The cost of a depreciable asset includes all the costs needed to purchase it and the costs incurred to finally put it to use. This includes the purchase cost, shipping cost, taxes, installation cost, and any other cost that may have been incurred to procure the asset. 
2. Useful life: Once the actual cost of the asset is determined, the company needs to estimate its useful life. Each depreciable asset will have a different useful life and hence will be treated accordingly in journal entry calculations. 
3. Depreciation method: Another thing the company needs to consider to calculate the depreciation expense journal entry of an asset is the depreciation method. This will again depend on the type of asset that is being depreciated. Businesses should also consider the complexity and tax implications of each depreciation method. For example, while straight line depreciation is simpler, the double declining depreciation method front-loads the depreciation expense, resulting in better tax deductions early on. 
4. Salvage value: Salvage or residual value is the cost at which you can sell the asset at the end of its useful life. This value plays a role while calculating the depreciation expense depending on the depreciation method a company uses. 

Now let’s see how to calculate the depreciation expense for each of the depreciation methods.

• Straight line depreciation

  This is the simplest way to calculate depreciation and only requires you to consider the cost, salvage value, and the useful life of the asset. 

  Formula: (Cost – Salvage value)/Useful life

• Double declining depreciation

  In order to calculate depreciation through the double declining method, you need to take into account the purchase value of the asset. 

  Formula: 2 x (1/Useful life of asset) x Book value at the beginning of the year

• Units of production depreciation

  To calculate depreciation through the units of production method, you need to determine the number of units the asset is capable of producing and the life of the asset in units in addition to its cost and salvage value. 

  Formula: (Number of units produced / Total units the asset is expected to produce) x (Cost of asset – Scrap value of asset)

• Sum-of-the-years depreciation

  For this depreciation method, you need to evaluate the remaining life of the asset and the sum of the years’ digits. 

  Formula: (Remaining life of the asset / Sum of the years’ digits) x (Cost of asset – Scrap value of asset) 

How to Record Depreciation Journal Entry

To record an accounting entry for depreciation, a depreciation expense account is debited and a contra asset account (accumulated depreciation) is credited. Apart from this, businesses need to understand where and how the entries go on financial statements, and the depreciation method they should use. 

Here’s a step-by-step guide to record a depreciation journal entry:

1. Calculate the depreciation amount for the asset using any one of the depreciation methods. 
2. To prepare the journal entries, determine the accounts that are going to be involved. These will be depreciation expenses and accumulated depreciation accounts. 
3. Record the journal entry by debiting and crediting the following accounts:
4. Debit the depreciation expense account. This will appear on the income statement at the end of the accounting period. 
5. Credit the accumulated depreciation account. This will be reflected on the balance sheet. 

To understand the process better, let’s look at an example. 

Depreciation Journal Entry Example

Let’s suppose a company buys equipment for $5,000 with a useful life of 5 years and zero salvage value. 

According to the straight-line depreciation method, the depreciation expense will be $1,000 per year. 

The company will record the following journal entry at the end of the first year: 

Let’s consider the same scenario and calculate the depreciation expense using the double declining method. 

In addition to the above values, we will now calculate the depreciation rate as well. 

With a useful life of five years, the depreciation rate for the asset (2/useful life) will be 0.4.

Year 1 depreciation expense (cost X depreciation rate): $2000

The following journal will be recorded for year 1:

Now, to calculate the depreciation expense for year 2, we will need to determine the new book value of the asset as well. 

New book value (cost – depreciation expense): $3000

According to the new book value, the depreciation expense for year 2 will be: $1200

The journal entry for year 2 will be the following:

The depreciation expense will be calculated similarly for the remaining life of the asset. 

Benefits of Depreciation Accounting Entry

Depreciation accounting entries are highly beneficial for businesses as they allow them to manage their finances better. Here are some of the major advantages of recording a depreciation accounting entry:

1. Accurate financial reporting: Depreciating assets allows a company to show their actual, decreased value over a period of time, resulting in accurate financial statements. Allocating the cost of an asset over its useful life further helps prevent any major fluctuations in the profit and loss statement. Due to this, businesses are able to report a reliable and stable overview of their financial position. 
2. Tax benefits: Large assets such as vehicles and real estate provide tax benefits to businesses. Depreciating such assets further helps in reducing the taxable income for businesses. 
3. Expense matching: Probably one of the key benefits of the depreciation journal entry is that it helps businesses adhere to the matching principle of accounting. Depreciating assets ensures that their cost is aligned with the revenue they help a business generate, thereby depicting profitability in a much more accurate way. 
4. Asset management: The process of recording a depreciation journal entry requires businesses to determine the useful life and the current value of an asset. This ensures that companies are prepared for maintaining, upgrading, and replacing assets as needed. 
5. Adherence to accounting standards: Accounting standards such as GAAP and IFRS require businesses to depreciate tangible assets over time during their useful life. 

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