Overview:
According to International Accounting Standards, the cost of a long-term asset should not be expense out in a single year profit & loss. It states that this cost should be capitalizing on its estimated useful life.
The depreciation is an expense allowed to deduct from the company’s profit. This is a non-monetary expense. And only arrives due to the natural wear and tear in the life of an asset. This wear and tear decrease the asset’s life, and ultimately, the firm should be going to purchase a new one.
International Accounting Standard(IAS) 16 defines the property, plant, and equipment with how to determine their estimated life and how to depreciate them over time. You can study the IAS=16 for further reference.
How to calculate the depreciation expense:
To calculate the depreciation expense, companies might use one of the following methods:
The GAAP recommended the straight-line method to calculate the depreciation expense. Let have a look at the example so you can easily understand the idea:
| Description | Amount $ |
| Value of Property, Plant, and Equipment | 1,800,000 |
| Estimated useful life | 20 years |
| Salvage value at the end of 20 years | 200,000 |
The depreciation expense will be calculated on the following formula:
Depreciation expense = Amount of Asset – (Residual Value)/Estimated life of Asset
Depreciation Expense = $1,800,000 – $200,000/20
Depreciation Expense = $80,000 per year
So 80,000 is the total depreciation expense for the year. This amount should be deducted from the income statement of the company.
There is no actual expense in the shape of money, but this is the capitalized amount of fixed assets. To record these entries in the books of accounts, we created an account called accumulated depreciation account. This account is used to record total depreciation expenses for the whole life of the said asset.
Accounting Entries to Record Depreciation:
The above entries should be recorded in the following manner. At the yearend like 30, Dec we will record the following entries
Dr Depreciation expense (Income Statement) $80,000
Cr Accumulated depreciation (Balance Sheet) $80,000
So in the first year, we have changed the depreciation expense to the income statement, and we have a credit balance of 80,000 in our accumulated depreciation account.
In the next year, the depreciation expense will be the same 80,000, and the following entry should be passed:
Dr Depreciation expense (Income Statement) $80,000
Cr Accumulated depreciation (Balance Sheet) $80,000
It means that we charge depreciation expenses for the year in the second year to the income statement. While the accumulated depreciation account will be increased to 160,000 as of the 80,000 from the second year also add up within the account. The accumulated depreciation account will add up all the depreciation expenses through the asset’s life.
And when the carrying amount becomes the residual amount of asset. And company sells the asset for a value of its residual, and then we should record this entry.
Dr Cash $4200,000
Cr Accumulated depreciation $1600,000
Cr Property, Plant and Equipment $1800,000
So in this way we calculate and record the depreciation expense. In this example, we use the straight-line method to calculate the value of depreciation. You can also use any method, but the entries will be the same for all the methods.
Benefit of Calculation Depreciation:
The main idea behind the depreciation is the matching concept used in accounting standards. Because this is not logical, when you buy a new asset, you less the value from the company income statement. As the asset is not used for the very first time. So the standards say that when the asset is installed and ready to use, you should calculate its life and depreciate its amount over the estimated period.
