Depreciation is the loss of value of a business asset due to wear and tear over time. It is recorded as a debit on the income statement and a credit on the balance sheet. The amount of depreciation is calculated using different methods and does not represent a loss of cash.
Depreciation refers to the amount of value lost by an asset, which is used for business purposes due to wear and tear over the time it is used. The accounting entry for depreciation is represented on both a company’s balance sheet and its income statement. On the income statement, the entry for depreciation is a debit account that represents the amount of depreciation the asset has suffered in that accounting period. In contrast, the balance sheet entry is a credit and represents the amount of depreciation that has accumulated on the asset up to that point.
Any asset used by a business, such as a car, computer, or building, suffers a loss of value as it is used over a period of time. That loss of value, known as depreciation, is an important principle for companies to understand when it’s time to compile their accounting. The entry for depreciation is based on the matching principle, whereby the income earned on an asset is offset by the value lost over time.
On a balance sheet, the entry for depreciation accumulates over time. It is known as a contra account because it works against the cost of depreciation and is generally filed under title to property, plant and equipment. The entry is a credit on the balance sheet and carries over from one period to the next. For example, a business vehicle that has depreciated over five years at a rate of $200 US dollars (USD) per year would have accumulated depreciation of $1,000 USD on the balance sheet.
By contrast, the entry for depreciation on an income statement, which determines the taxes a business must pay, is a debit account and is only temporary. The annual amount of depreciation is known as depreciation expense. This amount is reset each year and does not carry over. Using the example above, the depreciation expense for the vehicle in the first year would be $200, and it would still be $200 in the second, third, and so on.
The depreciation amount of an asset is calculated using several methods, the two general methods being the straight-line method, in which the same amount is amortized each year, and accelerated depreciation, in which a larger amount is amortized the first year. with decreasing amounts depreciated each successive year. It is important to note that the depreciation expense entry does not represent a loss of cash to the business, but rather a loss of revenue. Additionally, the cost of the asset listed on the balance sheet after depreciation may not be representative of the asset’s actual market value, but is simply an attempt, through accounting, to balance cost and expense.
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