What is it? First let’s remember our definition for an

expense Something that we spend money on to

make money

Based on this definition shouldn’t things like equipment or cars be expenses? We use these things to make money do we not?

However, items such as a car don’t suddenly become worthless – it loses some of it’s value each year

So, a portion of the cost of the equipment should be allocated as an expense in each year of the item’s life

Like our prepaid accounts – this ensures the business meets the matching principle

Depreciation an allowance made for the decrease in value of an asset over time

Depreciation is an expense so it appears on the INCOME STATEMENT

Depreciation Expense – Debit Account

Since there was a debit – we now know we need a credit

This sets up another new accountAccumulated Depreciation for each

asset will be established ....just for the ones that are worth less

over time (equipment, automobiles, etc) Accumulated Depreciation is our 2nd

CONTRA account

Accumulated Depreciation is a contra account to the asset it is depreciation It takes away value from the overall

account of the asset

Automobile 15000Less: Accumulated Depreciation

800 14200

The amount to depreciated every fiscal period is not always given

Methods for calculation 2 most common are:▪ Straight Line▪ Declining Balance

Straight Line Method Divides up the net cost of the asset

equally over the years of the assets life

Straight Line for 1 yr = (orig cost - estimated salvage value)Estimated # of periods in the asset’s life

Straight line Example Tip Top Trucking purchased a truck for

$78000 on Jan 1. 2011. Truck could be used for 6 years, and be sold at that time for $7800.

Therefore:Estimated Annual Depreciation is($78000 – $7800) / 6 = $11700The truck will depreciate $11700 each

year.

Recording DepreciationJournalDepreciation Expense – Truck 11700

Accumulated Depreciation - Truck11700

So the entry will look like this:JournalDepreciation Expense – Truck

11700Accumulated Depreciation - Truck11700The use of the accumulated depreciation account

provides 2 types of information:1) By not taking the depreciation right off of the asset account we can still find the original cost of the asset2) We can quickly calculate the total amount of depreciation recorded over the years

Adjusting Entry for Depreciation1) records the depreciation for the

period in the depreciation expense account

2)Increases the appropriate accumulated depreciation account for the asset, which reduces the asset’s net book value

Journalized as…Depreciation Exp $$$$

Acc. Dep. (Asset) $$$$

Declining-balance Method Allocates a greater amount of depreciation to the

first years of an asset’s life

This is the method the government requires for income tax purposes

To find the depreciated amount you take the undepreciated cost of the asset and multiply it by a fixed % This % is set by the gov’t

For example Equipment may have cost $12,000 The car is to be depreciated at a rate of

20% per year

Year Undepreciated Cost

Amount of Depreciation (20%)

Declining Balance, End of Year

1 12000 2400 9600

2 9600 1920 7680

3 7680 1536 6144

4 6144 1228.80 4915.20

5 4915.20 983.04 3932.16

Again, the depreciation expense accounts are listed on the income statement as a debit

The Accumulated Depreciation are listed with their contra-accounts on the balance sheet

Equipment -> Accumulated Depreciation: Equipment

Acc. Depreciation is a credit account on your trial balance

Fixed AssetsEquipment xxLess: Accumulated Depreciation – Equipment xx xxFurniture xxAutomobile xxLess: Accumulated Depreciation – Automobile xx xxBuilding xxLand xx

Total Fixed Liabilities xx

Page 218-219Questions 3-6