Two methods are normally used to record the
depreciation in the books. These are:
-
Depreciation account - no provision for
depreciation account is maintained
-
Accumulated depreciation account - provision for
depreciation account is maintained
These methods have been explained below:
Under this method, depreciation account is
debited and asset account is credited with the
amount of annual depreciation.
Example:
Suppose, the cost of a machine is $1,000 and its
depreciation is 10% p.a. The entries to record the
depreciation will be:
Journal Entries
| Depreciation a/c |
Dr. |
100 |
|
|
Machinery a/c |
|
|
100 |
| (Being
depreciation charged on
machinery @10% p.a.) |
|
|
|
|
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|
|
| Profit and loss
a/c |
Dr. |
100 |
|
|
Depreciation a/c |
|
|
100 |
| (Being transfer
of depreciation) |
|
|
|
|
The depreciation will be shown
in the profit and loss account as follows:
Profit and Loss A/C
For the year ended .......
|
Other Expenses |
XXX |
Gross profit |
XXX |
|
Depreciation |
XXX |
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The asset will be shown in the
balance sheet as follows:
Balance Sheet
as at........
|
Assets |
|
$ |
Liabilities |
$ |
|
Machinery |
1,000 |
|
|
|
|
Less Depreciation |
100 |
900 |
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This method of recording
depreciation has now fallen into disuse. It has
the effect of reducing the balance shown in the
ledger for the fixed asset so that over time, it
may be very much less than the original cost.
This makes it difficult to identify the original
cost of fixed assets and means that, the only
information that can be given is the value to
which each fixed asset has been written down.
Anyone looking at this information will have no
way of assessing whether a fixed asset was
originally very expensive (which may be
relevant, for example, if it is a building) and
so cannot arrive at a realistic view of what the
fixed assets really comprise. Nor, especially in
the case of smaller business, is it immediately
obvious how long a fixed asset is likely to
continue to be used or, in fact, whether there
is actually an asset in current use - if the
value has been written down to zero, it wouldn't
have a balance, may have been written out of the
ledger, and certainly wouldn't be included in
the balance sheet.
This method involves maintaining each fixed asset
at its cost in the ledger account while operating
another ledger account where the depreciation to
date is recorded. This account is known as
accumulated provision for depreciation account,
often shortened to the accumulated
depreciation account (or sometimes,
confusingly, known as the provision for depreciation
account).
Let's look at how this method of recording
depreciation is applied by first looking at the
double entry required and then looking at it being
used in the example.
The depreciation is posted directly into the
cumulative provision for depreciation account. The
double entry to record the depreciation is as
follows:
| Debit the profit and loss a/c |
| Credit the
accumulated depreciation a/c |
Example:
In a business with financial years ended 31
December a machine is bought for $2,000 on 1 January
2005. It is to be depreciated at the rate of 20 per
cent. using the reducing balance method. The records
for the first three years are:
Machinery
|
2005 |
|
$ |
|
|
$ |
|
Jan. 1 |
Cash |
2,000 |
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Accumulated Provision for Depreciation -
Machinery
|
2005 |
|
$ |
2005 |
|
$ |
|
Dec. 31 |
Balance c/d |
400 |
Dec. 31 |
Profit and loss a/c |
400 |
| |
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2006 |
|
|
2006 |
|
|
|
Dec. 31 |
Balance c/d |
720 |
Jan. 1 |
Balance b/d |
400 |
| |
|
|
Dec. 31 |
Profit and loss a/c |
320 |
| |
|
|
|
|
|
| |
|
720 |
|
|
720 |
| |
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2007 |
|
|
2007 |
|
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|
Dec. 31 |
Balance c/d |
976 |
Jan. 1 |
Balance b/d |
720 |
| |
|
|
Dec. 31 |
Profit and loss a/c |
320 |
| |
|
|
|
|
|
| |
|
976 |
|
|
976 |
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2008 |
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Jan. 1 |
Balance b/d |
976 |
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Profit and Loss Account (extracts) for
the year ended 31 December |
| 2005 |
Depreciation |
400 |
| 2006 |
Depreciation |
320 |
| 2007 |
Depreciation |
256 |
Now the balance on the machinery
account is shown on the balance sheet at the end
of each year less the balance on the cumulative
provision for depreciation account.
| Balance
Sheet (extracts) |
| |
$ |
$ |
|
As at 31 December 2005 |
|
|
| Machinery at cost |
2,000 |
|
| Less accumulated
depreciation |
(400) |
1,600 |
| |
|
|
|
As at 31 December 2005 |
|
|
| Machinery at cost |
2,000 |
|
| Less accumulated
depreciation |
(720) |
1,280 |
| |
|
|
|
As at 31 December 2005 |
|
|
| Machinery at cost |
2,000 |
|
| Less accumulated
depreciation |
(976) |
1,024 |
| |
|
|
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