Chapter 11: Depreciation of Fixed Assets

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When an asset is purchased that will last more than one year the cost of the asset is not counted as an expense. Instead the cost is spread over many years using depreciation.

In Straight-Line Depreciation the cost is spread evenly over the expected life of the asset. For example if you purchase equipment for $5k that is expected to last 5 years then for each of the next 5 years $1k is counted as an expense

The day the equipment is purchased
Journal Entry
Equipment $5k
Cash $5k
Each year for next 5 years
Journal Entry
Depreciation Expense $1k
Accumulated Depreciation $1k

Accumulated Depreciation is a contra account or more specially in this case a "contra-asset account" since it offsets the Equipment account. It just means that at any time the net of the debit balance in Equipment and the credit balance in Accumulated Depreciation gives the net Equipment balance which is also called "net book value". In this example after one year Equipment has a net book value of $4k (original cost minus accumulated depreciation), after 2 years the net book value is $3k and so on.

It's better to do credit entries to Accumulated Depreciation instead of directly touching the Equipment account so

  • 1. We have a record of the original cost
  • 2. We have a record of the depreciations used
The Equipment is disposed off after 5 years (with net book value of zero)
Journal Entry
Accumulated Depreciation $5k
Equipment $5k

Now there is a zero balance in both the equipment account and the accumulated depreciation account.

Salvage Value

Sometimes also called residual value, is the what an asset is expected to be worth after using it for a number of years. For example you buy furniture for $11k which you plan to use for 10 years after which you estimate will be worth $2k. In this case, the depreciable cost is $9k and for the next ten years you record $900 depreciation.

Each year for next 10 years
Journal Entry
Depreciation Expense $900
Accumulated Depreciation $900
If you were spot on and then sold it for $2k
Journal Entry
Cash $2k
Accumulated Depreciation $9k
Furniture $11000

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  • 10 months ago by vince