The Accounting Concept of Depreciation

Depreciation expense reduces a firm's tax liability.

Fixed assets, also called long-term assets, represent large portions of corporate balance sheets. Senior executives ensure that accountants depreciate fixed assets in accordance with generally accepted accounting principles and international financial reporting standards.

Definition

Depreciation is an accounting term meaning spreading the cost of a fixed asset over many years. An accountant depreciates a fixed asset through a straight-line method or an accelerated method. Examples of long-term assets include machinery and equipment.

Straight-Line Depreciation

In a straight-line depreciation process, a fixed-asset accountant records even depreciation amounts every year. For instance, a firm buys a truck valued at $50,000 and depreciates it over five years. The annual depreciation expense is $10,000 ($50,000 divided by five).

Accelerated Depreciation

In an accelerated depreciation process, a fixed-asset accountant records higher depreciation expense amounts in earlier years. For instance, the company wants to depreciate the truck at "50-30-20 accelerated method." At the end of the first year, the accountant records $25,000 in depreciation expense ($50,000 times 50 percent).

Accounting for Depreciation

To record depreciation expense, a fixed-asset accountant debits the depreciation expense account and credits the accumulated depreciation account.

Reporting Depreciation Expense

Accounting rules require a company to indicate depreciation entries in financial statements at the end of each quarter or year. The depreciation expense account is included in the income statement, while the accumulated depreciation account is a balance sheet item.

References

• Business Town: Depreciation
• Investopedia: Depreciation Accounting