Depreciation expense and Accumulated Depreciation. Financial Accounting

In this video, we will discuss depreciation expense and accumulated depreciation.
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Understanding Depreciation Expense and Accumulated Depreciation
Depreciation is a fundamental accounting concept used to allocate the cost of a tangible asset over its useful life. This process recognizes the wearing out, consumption, or other loss of value of a physical asset, such as machinery, vehicles, or buildings. Here, we delve into two key components of depreciation: depreciation expense and accumulated depreciation.

1. Depreciation Expense
Depreciation expense represents the portion of the total cost of a tangible asset that is considered to be consumed during a specific accounting period. This expense is recognized on the income statement and impacts the profit and loss of a company.

Purpose: The primary purpose of recording depreciation expense is to reflect the usage and economic reduction in value of an asset over a given period, adhering to the matching principle of accounting. This principle dictates that expenses should be matched with the revenues they help generate.

Calculation: Depreciation expense can be calculated using various methods, each suitable for different types of business activities and asset types:

Straight-Line Method: This method spreads the cost of the asset evenly over its useful life. It is calculated by dividing the depreciable base (cost minus salvage value) by the useful life of the asset.
Declining Balance Method: A form of accelerated depreciation where a fixed percentage of the book value of the asset is expensed each year, leading to higher expenses in the earlier years.
Units of Production Method: Calculates depreciation based on the usage or output of the asset rather than the passage of time.
2. Accumulated Depreciation
Accumulated depreciation is a contra asset account on the balance sheet that records the total depreciation expense that has been charged against a fixed asset since it was acquired and put into use.

Purpose: Accumulated depreciation serves to show the aggregate impact of depreciation on the historical cost of assets. It helps determine the net book value (cost minus accumulated depreciation) of the assets.

Account Behavior: Unlike typical asset accounts that have a debit balance, accumulated depreciation has a credit balance. It increases with each debit to the Depreciation Expense account and reduces the gross amount of fixed assets reported on the balance sheet.

3. Accounting Entries
When recording depreciation, the typical journal entries for each accounting period are:

Debit Depreciation Expense: This increases the expense on the income statement, reducing net income for the period.
Credit Accumulated Depreciation: This increases the total accumulated depreciation on the balance sheet, reducing the book value of the asset.
4. Example of Depreciation Accounting
Consider a company that purchases a machine for $10,000, expected to have a salvage value of $1,000 at the end of its useful life of 5 years. Using the straight-line method, the annual depreciation expense would be calculated as follows:

Depreciable Base: $10,000 - $1,000 = $9,000
Annual Depreciation Expense: $9,000 / 5 years = $1,800
Each year, the journal entry would be:

Debit Depreciation Expense $1,800
Credit Accumulated Depreciation $1,800
5. Impact on Financial Statements
Income Statement: Depreciation expense reduces the operating income and, consequently, the net income.
Balance Sheet: While the original cost of the asset remains unchanged in the asset section, the accumulated depreciation account increases, decreasing the net book value of the asset.
Conclusion
Depreciation expense and accumulated depreciation are crucial for providing a realistic picture of the value and expense associated with using tangible assets over time. Proper management and recording of these figures are essential for accurate financial reporting and compliance with accounting standards.



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