Accounting standards require companies to separate capital expenditure from revenue expenditure. Both are crucial in determining the period to which an expense applies. On top of that, it also conforms to the matching concept in accounting. Revenues expenditure usually becomes a part of the expenses on the income statement for the period it occurs.
For capital expenditure, a prevalent method of charging expenses is depreciation. Companies charge depreciation expenses to the income statement for a period. Before discussing that expense, it is crucial to understand depreciation.
What is Depreciation?
Depreciation refers to the cost of an asset spread over its useful life. It also represents the reduction in the record cost of that asset in a systematic way. Usually, depreciation applies to every resource until the useful life of that asset is over. If a company disposes of that asset before that period, depreciation will also stop.
Depreciation is a crucial concept in helping companies expense out assets. It allows them to match the expense for those assets to the same period they generate revenues. Except for land, it applies to every tangible fixed asset. Companies choose the best depreciation method to expense an asset’s cost over its useful life. Based on that method, companies can calculate the depreciation expense.
What is Depreciation Expense?
Depreciation expense refers to the depreciation charge for a period based on the calculation of all assets. Companies charge this expense to the income statement for a specific period. Also known as a non-cash expense, depreciation expense is a common item on the income statement for all companies. Companies may divide this expense between several assets based on a specific percentage.
Depreciation expense also reduces the total value of an asset on the balance sheet. It becomes a part of the accumulated depreciation and increases the balance each period. On the other hand, it also decreases profits through expenses. The accounting for depreciation expense also reflects the two areas it impacts.
How to Calculate Depreciation Expense?
Companies can calculate depreciation expenses in many ways. The three most common methods are as below.
The straight-line method of depreciation allocates its cost over its useful life. It results in the same depreciation expense for every period throughout that life. Companies use the following straight-line depreciation formula.
Depreciation expense = (Asset’s cost – Asset’s scrap value) / Asset’s useful life
The double-declining method assigns a higher depreciation expense for the initial periods of the asset’s life. It is a type of accelerated depreciation method that charges double the value of depreciation as the declining method. The formula for this method is as below.
Depreciation expense = 2 x Asset’s book value x Depreciation percentage
Unit of production method
The unit of production method calculates the depreciation based on the units produced by an asset. It estimates the per-unit depreciation cost and allocates it based on the total units produced. The formula for this method is as below.
Depreciation expense = Asset’s units produced x [(Asset’s cost – Asset’s scrap value) / Useful production units produced]
What is the accounting for Depreciation Expense?
The accounting for depreciation expenses is straightforward. As stated above, it involves increasing expenses and adding them to the accumulated depreciation balance. The journal entries for depreciation expenses are as below.
Depreciation expense refers to the charge included in the income statement for assets depreciated for a period. Companies can calculate this expense using many methods. However, three of these methods are more common than others. The accounting for depreciation expense increases that expense while also impacting accumulated depreciation.
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