{m}.{s}.1Double entry: Depreciation of asset

Step 1

We will consider the car purchased in 2006 for £5,000. Let us depreciate this in 2006 at 20% using the reducing balance method.

Depreciation for 2006 is 20% x £5,000 = £1,000.

As discussed earlier we are charging depreciation to profit. We must, therefore, have a new expense account to be able to do this - the Depreciation (expense) account.

We want to increase our expenses (i.e. debit) by this amount. We will therefore debit the Depreciation account.

Where will we make the credit entry? We want to decrease the value of the asset - we will therefore, for now, credit the asset - Motor car account.

Motor car
Bank 5,000 Depreciation 1,000
       
       
      
Depreciation
Motor car 1,000   
       
       
      
[{m}.{s}a]

 

Step 2

We can clearly see that:

Expenses (Depreciation) have increased

Assets (Motor car) have decreased

as part of the cost of the asset is written off as an expense.

Motor car
Bank 5,000 Depreciation 1,000
       
       
      
Depreciation
Motor car 1,000   
       
       
      

ASSET
    
+ - 
    
    
EXPENSE
    
+ - 
    
    
[{m}.{s}b]

 

Step 3

When the annual accounts are prepared, the balance in the Depreciation account is transferred to the profit and loss account in the same way as any other expense account.

This clears the Depreciation account to zero ready for next year's charges to be posted. The balance in our asset account will be included in the balance sheet. The balance is now £4,000 i.e. the original cost (£5,000) less the amount depreciated (£1,000).

Motor car
Bank 5,000 Depreciation 1,000
       
       
      
Depreciation
Motor car 1,000 P & L 1,000
       
       
      
[{m}.{s}c]

 

Step 4

The balance is now £4,000 i.e. the original cost (£5,000) less the amount depreciated (£1,000).

Motor car
Bank 5,000 Depreciation 1,000
    Bal c/d 4,000
  5,000   5,000
Bal b/d 4,000   
Depreciation
Motor car 1,000 P & L 1,000
       
       
      
[{m}.{s}d]

 

Step 5

Note that once the balance of £4,000 is carried forward we have lost a lot of information. We cannot tell (without looking back to previous entries) if the asset cost £5,000 and has been depreciated by £1,000 or perhaps cost £25,000 and has been depreciated by £21,000.

The only figure that is clearly shown is the net book value of £4,000. We will, therefore, look at a clearer method of recording the entries in the asset accounts.

Motor car
Bank 5,000 Depreciation 1,000
       
       
      
Depreciation
Motor car 1,000 P & L 1,000
       
       
      
[{m}.{s}e]

{m}.{s}.2Accumulated depreciation account

Step 1

 

Motor car - cost
Bank 5,000 Depreciation 1,000
       
       
      
Motor car - acc depn
      
       
       
      
Depreciation
      
       
       
      
[{m}.{s}f]

Car purchased in 2006 for £5,000. Depreciation - 20% reducing balance.
Depreciation for 2006: 20% x £5,000 = £1,000.

 

In this method, instead of crediting the depreciation against the cost of the asset as presently shown, a new account is opened, the Accumulated Depreciation Account, and the depreciation is credited there.

Step 2

[{m}.{s}g]

Step 3

 

Motor car - cost
Bank 5,000   
       
       
      
Motor car - acc depn
    Depn 1,000
       
       
      
Depreciation
Acc depn 1,000 P & L 1,000
       
       
      
[{m}.{s}h]

As before, the balance in the Depreciation account is transferred to the profit and loss account.

The balances in the Motor car - cost and Motor car - accumulated depreciation accounts will appear in the balance sheet. Note that the Motor car - acc depn account is also grouped with the asset accounts even though it has a credit balance.

 

Step 4

 

Motor car - cost
Bank 5,000 Bal c/d 5,000
  5,000   5,000
Bal b/d 5,000    
      
Motor car - acc depn
Bal c/d 1,000 Depn 1,000
  1,000   1,000
    Bal b/d1,000
      
Depreciation
Acc depn 1,000 P & L 1,000
       
       
      
[{m}.{s}i]

The credit balance in this account decreases assets.

 

Step 5

The figures will show in the balance sheet [right]:

The same final figure of the net book value of £4,000 is arrived at as before but much more information is readily available.

FIXED ASSETS  
Motor car- cost 5,000
Motor car- accumulated depreciation (1,000)
  4,000
[{m}.{s}j]

{m}.{s}.3Example 1: Depreciation charge

Let us consider the second asset purchased by the same business in 2006 for £3,200.

The depreciation being charged for 2006 is 10% straight line depreciation.

Open/Close{m}.{s}.Q1
Open/Close{m}.{s}.Q2
Open/Close{m}.{s}.Q3
Open/Close{m}.{s}.Q4

{m}.{s}.4Example 2: Later years

Entries will be made in the accounts in later years in the same way.

Let us consider the asset accounts for 2007. A new car is purchased, for cash, in the year for £6,500. A new item of machinery is purchased, on credit, for £1,600 (net of VAT).

Our T accounts in 2007 with these items included, will be as follows:

Open/Close{m}.{s}.Q5
Open/Close{m}.{s}.Q6
Open/Close{m}.{s}.Q7
Open/Close{m}.{s}.Q8
Open/Close{m}.{s}.Q9
A1 Machinery - cost
Purchase3,200 Bal c/d 4,800
Creditors 1,600    
  4,800   4,800
Bal b/d 4,800   
A2 Machinery - acc depn
Bal c/d 800Bal b/f 320
    Depn 480
  800   800
    Bal b/d 800
E10 Depreciation
M/c acc dep 480 P&L 2,580
Car acc dep 2,100    
  2,580   2,580
      
A3 Motor Car - Cost
Bal b/f 5,000   
Bank 6,500    
  11,500   11,500
Bal b/d 11,500   
A4 Motor Car - acc depn
Bal c/d 3,100 Bal b/f 1,000
    Depn 2,100
  3,100   3,100
    Bal b/d 3,100