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DEPRECIATION BASICS! With Journal Entries
Types of depreciation
The following section will review the different types of depreciation that are used.
Declining balance depreciation is a method of accelerated depreciation that depicts how the value of depreciation goes down as a fixed asset is used.
Equation: Straight-line percentage x the remaining depreciable amount for each year
This type of depreciation is also considered an accelerated depreciation method. The double-declining balance depicts how the amount of depreciation will move quickly at the beginning of an assets life cycle and gradually decline toward the end of an assets life cycle.
Equation: 2x (original cost of an asset – the scrap value / estimated asset life)
Straight-line depreciation is the most common depreciation method to use. It requires that a company spreads out an assets depreciation expenses evenly across each year that an asset is estimated to work and function properly.
Equation: (Original cost of an asset – scrap value) / estimated asset life
Units of production
Units of production is a type of depreciation where a business changes the charge amount of an assets depreciation depending on how much an asset is used during a given period of time. Unlike the straight-line method, it does not spread out even charges over an assets lifecycle. Instead, it charges depreciation as an asset that is actively being used.
Equation: (Cost of fixed asset – residual value / estimated total production) x actual production
This is an accelerated depreciation method where businesses charge more for depreciation at the beginning of an assets lifecycle and slowly decrease the depreciation charges the longer a company uses an asset.
Equation: Deprecation base x (remaining useful life/sum of the years digits)
What is depreciation?
Depreciation is a method used in accounting wherein a company spreads out the cost of an asset (product, equipment or department) throughout its lifecycle. Another way to define depreciation is by saying that over time, the value of an asset will decrease.
How to record depreciation
This section will provide a step-by-step guide on how to record depreciation on your companys financial documents.
1. After purchasing an asset, record it on company documents
Directly after your company purchases an asset (company equipment, furniture, products, building or department), record the cost of the asset on your companys financial documents. First, record the asset as debit to increase an asset account on the balance sheet. Then, record the same amount as credit to reduce cash or increase accounts payable, on the balance sheet.
2. Gradually transfer an assets cost as its used
As an asset begins to be used, the depreciation of that asset is taken out. Therefore, the cost of the asset is gradually transferred from your companys balance sheet to the income statement.
3. Record depreciation for assets still in use toward the end of the fiscal year
At the end of each fiscal year, record the amount of depreciation that occurs for an asset that still carries some value. This should be labeled as debit to depreciation expense on the income statement and credit to accumulated depreciation on your companys balance sheet. If an asset has become fully depreciated, do not record it on your companys financial documents.
The following example will use a fictional construction company to demonstrate how to effectively charge depreciation of an asset.
1. Purchase of an asset
Morley Construction bought a new bulldozer for $75,000 in 2010. At the time of the purchase, the equipment vendor guaranteed that the bulldozer would function properly for a span of five to seven years.
2. Recording of an asset
The accounting department at Morley Construction enters this new asset into the companys balance sheet. They record the asset as bulldozer for $75,000 as a debit to increase an asset account and record the same amount as credit to reduce cash.
3. Choosing a depreciation method
Now the accounting department must choose a method of depreciation to measure the bulldozers value over time. Since the equipment vendor guaranteed the bulldozer to last five to seven years and because the bulldozer might not be continuously in use, they decide to implement the units of production method to charge the depreciation of their new asset.
They chose this method because it allows them to record the specific periods of time where the bulldozer is actually in use. They can then charge the resulting depreciation from each separate instance.
4. Calculating the depreciation charge for a given project
To find out the depreciation of a specific period of usage, they first identify the cost of the fixed asset as $75,000. Then, they identify the bulldozers residual value (estimated worth at the end of its functional life) at $5,000. They use the estimated total production time it could contribute to the company as being five years or 1,825 days. They, then, identify the amount of time it was needed to be 10 days.
Once the accountants have these figures, they plug them into the following equation:
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What is a depreciation example?
What is depreciation in accounting?
What is depreciation and how is it calculated?