What is Depreciation?

Accounting student often ask, what is depreciation?

Depreciation is the systematic reduction in recorded value of Property Plant and Equipment assets due to their wear and tear,
obsolescence and age.

In choosing the depreciation method, the entity needs to consider;

• The depreciable amount (or base) ( no GST),
• The useful life,
• The residual value, and
• The method that reflects the pattern of loss in value.

The end of accounting period journal to create depreciation in the accounts is;

Dr Depreciation Expense

Cr Accumulated Depreciation

How are these items treated in the Accounts?

This depreciation expense is written off each accounting period as an expense to the Profit and Loss Account.

Accumulated depreciation is offset against the depreciated asset in the balance sheet.

The effect of depreciation shows on the balance sheet in the asset section. The accumulated depreciation is the years of accumulated depreciation all added together.

The difference between the cost price of the asset and the accumulated depreciation is the written down value or what should be the current value of the asset.

    Cost Price of Asset

    Less Accumulated Depreciation

= Written down value (carrying value)

What methods are used to reduce an assets value through depreciation?

Common methods are the straight line method or the accelerated methods such as the reducing balance or diminishing balance.

The straight-line method reduces an asset by a steady, even amount each accounting period.

Accelerated methods such as diminishing balance reduce the asset by a greater amount in the early years. This then tails off over the life of the asset. These accelerated depreciation methods suit assets such as vehicles and computers because their value declines faster in the earlier years of the asset’s life.

Show me Some Examples of Depreciation Methods.

We can contrast the straight line and reducing balance methods though an example.

Let’s assume that both methods start with an asset that cost $20,000.

Both methods will aim to depreciate the asset over 5 years and have a disposal or residual value of 5,000 at the end of the 5 years.

Now to learn more about depreciation methods and have a teacher explain this to you with examples and a quiz, take this Depreciation Tutorial Course Depreciation Tutorial Course

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