Accounting for Depreciation of Non-current Assets

After calculating the depreciation expense using particular method like straight-line method or any accelerated method it is then recorded in accounting books of the entity.

Depreciation is an allocation of cost to the period and a specific formula is used to do it. As it is a reduction in value of asset or consumption of benefits, it is treated as an expense in the income statement and deducted from the cost of the asset in the statement of financial position.

Depreciation can be accounted for in two ways:

1. Record depreciation charge in the non-current asset’s account directly; or
2. Record depreciation charge in a separate contra-asset account usually named accumulated depreciation account

1 Accounting for depreciation in asset account

Depreciation charge is an expense therefore Profit and loss account is debited to record the expense. If the effect of depreciation is recorded directly in asset account then asset’s account will be credited with equal amount. Journal entry to record it will be:

 Profit and loss a/c \$\$\$ Asset a/c \$\$\$

Asset account to be credited will be the relevant account with the right account title. If we are recording depreciation of building then journal entry will be:

 Profit and loss a/c \$\$\$ Building a/c \$\$\$

Example: Accounting for depreciation in the asset account

Deosai Co. has recently bought some office equipment including personal computers for \$5,000. Deosai depreciates the equipment on straight-line basis using depreciation rate of 20%.

Give journal entries, T-account of asset and extracts of financial statements to record the depreciation for first three years.

Solution:

Journal entries

As depreciation method is straight-line therefore, depreciation will stay the same from year to year. Yearly depreciation is:

= 5,000 x 0.2 = 1,000

Journal entries for three years are:

 Year 1 Profit and loss a/c 1,000 Office equipment a/c 1,000 Year 2 Profit and loss a/c 1,000 Office equipment a/c 1,000 Year 3 Profit and loss a/c 1,000 Office equipment a/c 1,000

T-account

As depreciation is recorded straight in the office equipment account so only this account is relevant and recording for three years is as follows:

 Office Equipment Account Year 1 Year 1 Jan 1 Cash a/c 5,000 Dec 31 Profit and loss a/c Balance c/d 1,000 4,000 5,000 5,000 Year 2 Year 2 Jan 1 Balance b/d 4,000 Dec 31 Profit and loss a/c Balance c/d 1,000 3,000 4,000 4,000 Year 3 Year 3 Jan 1 Balance b/d 3,000 Dec 31 Profit and loss a/c Balance c/d 1,000 2,000 3,000 3,000
 Income Statement for the year ended _____________ (extract) Year 1 Depreciation expense 1000 Year 2 Depreciation expense 1000 Year 3 Depreciation expense 1000
 Statement of Financial Position as at _________________ (Extracts) \$ Year 1 Office equipment 4,000 Year 2 Office equipment 3,000 Year 3 Office equipment 2,000

2 Accounting for depreciation in Accumulated depreciation account

Although recording depreciation charge straight in the asset account is simple and clear as we can see above but it has one major problem. It distorts the information as it is “taking out” an important piece of financial statement.

For example if you see the balance of third year it is 3,000. If user does not have access to financial statements of first two years, it will be impossible to know the actual cost of the asset and how much depreciation has been charged so far. Due to this reason, the above method has long been obsolete and not used anymore.

Instead of recording the depreciation charge in the asset account and affecting the cost information, better way is to record the depreciation charge in a separate account. By the end of the period, the balance of asset account and total depreciation charge, better known as accumulated depreciation account, is set against each other to know the net book value of asset. This way we will always have the original cost of the asset and also the information related to total depreciation charged so far in the financial statements of the entity.

Example: Accounting for depreciation in Accumulated depreciation account

Deosai Co. has recently bought some office equipment including personal computers for \$5,000. Deosai depreciates the equipment on straight-line basis using depreciation rate of 20%.

Give journal entries, T-account of asset and extracts of financial statements to record the depreciation for first three years.

Solution:

Journal entries

Entity is using straight-line depreciation therefore, depreciation charge will remain the same from year to year. Journal entries are as follows:

 Year 1 Profit and loss a/c 1,000 Off. Equipment Accumulated Depreciation a/c 1,000 Year 2 Profit and loss a/c 1,000 Off. Equipment Accumulated Depreciation a/c 1,000 Year 3 Profit and loss a/c 1,000 Off. Equipment Accumulated Depreciation a/c 1,000

T-Account

As depreciation is recorded in separate account therefore, two accounts will be maintained. One for the asset itself and the other for depreciation charge over the years. Accounts of each for first three years are following:

 Office Equipment Account Year 1 Year 1 Jan 1 Cash a/c 5,000 Dec 31 Balance c/d 5,000 5,000 5,000 Year 2 Year 2 Jan 1 Balance b/d 5,000 Dec 31 Balance c/d 5,000 5,000 5,000 Year 3 Year 3 Jan 1 Balance b/d 5,000 Dec 31 Balance c/d 5,000 5,000 5,000
 Office Equipment Accumulated Depreciation Account Year 1 Year 1 Dec 31 Balance c/d 1,000 Dec 31 Profit and loss a/c 1,000 1,000 1,000 Year 2 Year 2 Dec 31 Balance c/d 2,000 Dec 31 Balance b/d Profit and loss a/c 1,000 1,000 2,000 2,000 Year 3 Year 3 Dec 31 Balance c/d 3,000 Dec 31 Balance b/d Profit and loss a/c 2,000 1,000 3,000 3,000

Financial Statements extracts

 Income Statement for the year ended _____________ (extract) Year 1 Depreciation expense 1000 Year 2 Depreciation expense 1000 Year 3 Depreciation expense 1000
 Statement of Financial Position as at _________________ (Extracts) \$ \$ Year 1 Office equipment 5,000 Accumulated depreciation 1,000 4,000 Year 2 Office equipment 5,000 Accumulated depreciation 2,000 3,000 Year 3 Office equipment 5,000 Accumulated depreciation 3,000 2,000