How to Record Depreciation

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Depreciation is a business write-off that allows a company to report lower income which leads to lower taxes. Its purpose is to account for the loss in value over an asset's useful life. There are several methods for depreciating assets, ranging from straight-line to accelerated. The tricky part about depreciation is that it is a non-cash expense. This means that no cash leaves the balance sheet, only the value attached to the asset. As such, a contra account, referred to as accumulated depreciation, was created to balance the books.

Review depreciation methodology. There are several methods to depreciate an asset (see Resources for a link to a guide from the IRS). These range from a simple straight-line method to accelerated methods. For this example, we will use a simple straight-line depreciation methodology.

Define the variables. Let's say you own a distribution company and just purchased a truck for $100,000 with a useful life of five years.

Calculate straight-line depreciation per year. The depreciation amount per year is equal to the "purchase price" divided by the "useful life." In the example given above, $100,000/5 = $20,000. In this scenario, you would record a depreciation expense for $20,000 every year for the next five years along with a separate entry for accumulated depreciation.

Calculate and record Year 1 accumulated depreciation. The depreciation base starts at $100,000. The depreciation base ($100,000) - annual depreciation expense ($20,000) = the new book value of the asset ($80,000). This is also the new depreciable base used to calculate Year 2 depreciation expense. The accumulated depreciation is $20,000. This should be a balancing entry against depreciation expense as a "contra asset" account.

Calculate Year 2 accumulated depreciation. The depreciable base is now $80,000, or the "purchase price" minus "accumulated depreciation" ($100,000 - $20,000). The depreciable base ($80,000) - annual depreciation ($20,000) = $60,000, which is the new depreciable base. The accumulated depreciation is $40,000 and should be recorded as a balancing entry against depreciation expense as a "contra asset" account.

Calculate Year 3 depreciation. The depreciable base is now $60,000, or the purchase price minus accumulated depreciation ($100,000 - $40,000). The depreciable base ($60,000) - annual depreciation ($20,000) = $40,000, which is the new depreciable base. The accumulated depreciation is $60,000.

Calculate Year 4 accumulated depreciation. The depreciable base is now $40,000, or the purchase price minus accumulated depreciation ($100,000 - $60,000). The depreciable base ($40,000) - annual depreciation ($20,000) = $20,000, which is the new depreciable base. The accumulated depreciation is $80,000.

Calculate Year 5 accumulated depreciation. The depreciable base is now $20,000, or the purchase price minus accumulated depreciation ($100,000 - $80,000). The depreciable base ($20,000) - annual depreciation ($20,000) = $0, which is the new depreciable base. The accumulated depreciation is $100,000 and the asset has been completely written off.

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