Accounting: Depreciation Basics
Depreciation is the spreading out of an asset's cost over the term of its useful life. Assets like buildings, equipment, and vehicles are subject to depreciation. Land is not subject to depreciation.
When a depreciable asset finishes its allotted term of useful life, it may still retain some residual value. This is the amount of money the business could expect to receive if it sold the asset at the end of its life; a vehicle, for instance, could be sold for scrap.
There are a few different ways to calculate depreciation, but we will save that discussion for another lesson. For now, just know the simplest method of depreciation, what is called straight-line depreciation. When an asset is depreciated in this way, it loses the same amount of value every year until it reaches its residual value. The formula for the straight-line method of depreciation is (Cost – Residual value) ÷ Useful life = Depreciation per Year.
The amount of depreciation an asset has undergone in its lifetime is called its accumulated depreciation. Accumulated Depreciation is a common contra-asset account: it is recorded directly under the associated asset in the Assets section of the balance sheet, but it has a normal credit balance. This presentation lets the reader know the original value of the asset as well as how much it has been depreciated.
Depreciation expense is recorded as an adjusting entry at the end of the accounting period. The adjusting entry for the depreciation on a piece of equipment typically is a debit to Depreciation Expense and a credit to the Accumulated Depreciation account associated with the piece of equipment. The adjusting entry for depreciation involves a credit to Accumulated Depreciation rather than to the related asset account because it is important to have a record of the asset's original cost.