Accounting Textbooks Boundless Accounting Controlling and Reporting of Real Assets: Property, Plant, Equipment, and Natural Resources Depreciation of Assets
Accounting Textbooks Boundless Accounting Controlling and Reporting of Real Assets: Property, Plant, Equipment, and Natural Resources
Accounting Textbooks Boundless Accounting
Accounting Textbooks
Accounting
Concept Version 7
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What Is Depreciation?

Depreciation is defined as the expensing of the cost of an asset involved in producing revenues throughout its useful life.

Learning Objective

  • Summarize the purpose of depreciating an asset

Key Points

    • Depreciation expense reduces the book value of an asset and reduces an accounting period's earnings. The expense is recognized throughout an asset's useful life.
    • The calculation of depreciation expense follows the matching principle, which requires that revenues earned in an accounting period be matched with related expenses.
    • Depreciation expense can be calculated in a variety of ways; the method chosen should be appropriate to the asset type, the asset's expected business use, and its estimated useful life.

Terms

  • residual value

    In accounting, residual value is another name for salvage value, the remaining value of an asset after it has been fully depreciated.

  • accrual accounting

    refers to the concept of recognizing and reporting revenues when earned and expenses when incurred, regardless of the effect on cash.

Full Text

Definition of Depreciation

Depreciation is defined as the expensing of an asset involved in producing revenues throughout its useful life. Depreciation for accounting purposes refers the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching of revenues to expenses principle). Depreciation expense affects the values of businesses and entities because the accumulated depreciation disclosed for each asset will reduce its book value on the balance sheet. Depreciation expense also affects net income. Generally the cost is allocated as depreciation expense among the periods in which the asset is expected to be used. Such expense is recognized by businesses for financial reporting and tax purposes.

Depreciation reflects the wear and tear experienced by an asset in use.

Cars depreciate in value throughout their useful life.

Depreciation and the Matching Principle

Depreciation expense reduces an accounting period's income even though the expense does not require a cash or credit payment. The reason for the expense is to comply with the matching principle required by accrual accounting. According to the principle, expenses are recognized regardless of cash payment when obligations are:

  1. incurred (usually when goods are transferred (sold) or services rendered),
  2. generated by expenses involved in the earning of the accounting period's revenues.

Depreciation Expense Calculation

Depreciation expense can be calculated using a variety of methods. The depreciation method chosen should be appropriate to the asset type, its expected business use, its estimated useful life, and the asset's residual value. The expense is recognized and reported when the asset is placed into use and is calculated for each accounting period and reported under Accumulated Depreciation on the balance sheet and Depreciation Expense on the income statement. The amount reduces both the asset's value and the accounting period's income. A depreciation method commonly used to calculate depreciation expense is the straight line method.

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