Back to: Accounting 101
Hello again!
Welcome to your second semester! In this lesson, we will be talking about depreciation – an important concept in accounting.
Let’s get started!
Accounting for Depreciation
Depreciation is the process of allocating the cost of an asset over its useful life. Instead of recording the entire cost of an asset like machinery, cars, or computers as an expense in the year it’s bought, depreciation spreads the cost over several years.
What is Depreciation?
Depreciation helps businesses spread the cost of an asset over its useful life. For example, if a company buys a delivery van for N500,000 and expects to use it for 5 years, depreciation will allow them to record a portion of that cost each year, rather than all at once.
Methods of Depreciation:
Straight-Line Method: The asset depreciates by an equal amount each year.
Reducing Balance Method: The asset depreciates more in the earlier years.
Why Depreciation is Important:
Depreciation helps businesses match their expenses with the income generated from those assets. It also reflects the decrease in value over time.
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. It is a non-cash expense that represents the decrease in value of an asset due to wear and tear, obsolescence, or other factors.
Depreciation is calculated by dividing the cost of the asset minus its residual value by its useful life. For example, if a company purchases a machine for ₦500,000 with a useful life of 5 years and a residual value of ₦100,000, the annual depreciation charge would be ₦80,000 (₦500,000 – ₦100,000 / 5 years).
There are several methods of depreciation, including the straight-line method, the reducing balance method, and the units of production method. The straight-line method is the most common method, where the depreciation charge is calculated as a fixed percentage of the asset’s cost. The reducing balance method, on the other hand, applies a fixed percentage to the asset’s carrying value each year, resulting in a decreasing depreciation charge over time. The units of production method depreciates the asset based on its usage or production levels.
Depreciation is recorded in the accounting records as a debit to the depreciation expense account and a credit to the accumulated depreciation account. The accumulated depreciation account is a contra-asset account that reduces the carrying value of the asset on the balance sheet. At the end of the asset’s useful life, the asset is removed from the balance sheet and the accumulated depreciation account is closed. Any remaining value of the asset is recognised as a gain or loss on disposal.
Conclusion:
Depreciation is important for accurate accounting. It ensures that a business’s financial statements reflect the true value of its assets over time.
Evaluation:
How would you calculate depreciation using the straight-line method for an asset worth N200,000 with a useful life of 4 years?
School Owner? Automate operations, improve learning outcomes and increase your income with Afrilearn SMSGet more class notes, videos, homework help, exam practice on Android [DOWNLOAD]
Get more class notes, videos, homework help, exam practice on iPhone [DOWNLOAD]