You have now been introduced to the concept of
. In a previous lesson, you
learned how to adjust for supplies, prepaid
, and late invoices. In this lesson, we
will introduce the concept of depreciation, the fourth common adjustment. At the end of
an accounting period, you must be able to determine the amount by which a fixed asset
has decreased in value as a result of usage and time.
, such as equipment or automobiles, are purchased by a company, they
are expected to bring value to the company over a number of years. As an asset is used
over those years, its value decreases as a result of usage, wear and tear, and the simple
passage of time. This decrease in value, each year, should be included with the
as the use of the asset helped contribute to the production of
for that period.
is defined as the process of allocating a part of the cost of a
fixed asset as an expense for each accounting period during which the business uses that
asset. With the exception of land, all
should be depreciated at the end of each
Here is a simple example to demonstrate how depreciation may work. On January 1, 20-
2, a company
a truck at a cost of $25,000 and the truck's useful life is expected
to be 8 years. One way of calculating the amount by which the truck decreases in value
over its life is to evenly divide the cost of the truck over the number of years of useful
life. Using this method, the truck will depreciate $3,125 each year ($25,000/8 years).
Therefore, it is important, at the end of each year (December 31), to recognize the $3,125
depreciation expense, as the use of the truck over each year helps to produce the
for each year.
There are two new accounts to be used when adjusting for depreciation.
is an expense account that shows the amount by which an
asset's value is decreased in a given period. This account is
ed, at the end of
each year, when the
is a contra-asset account* which is listed with the
fixed asset, on the
, to reduce its value. This account is
the end of each year, when the
is recorded. The actual fixed asset
account, in the
, will maintain its original balance, as dictated by the cost
principle. Therefore, rather than
ing the asset itself, the accumulated
depreciation account (contra-asset account) is
*Recall that a contra-account always has a type of balance (DR or CR) that is opposite to
the account with which it is associated. i.e. GST Recoverable (DR balance) is a contra-
account associated with GST Payable (CR balance), Accumulated Depreciation (CR
balance) is a contra-account associated with a fixed asset (DR balance).