Accounting Treatment of Depreciation

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on March 06, 2023

Explanation

After calculating depreciation using a suitable approach, it must be brought to books.

The accounting entries for depreciation are generally made at the end of each financial year. A new account called the depreciation account, or more appropriately the depreciation expense account, is opened in the books.

This account is debited by the amount of depreciation to be provided for the year. Alongside this, the fixed asset account concerned is credited by the same amount.

The effect of this entry is that the depreciation expense account shows the amount of expense for the year, while the fixed asset account shows a reduced balance.

The depreciation expense account, being a nominal account, is closed at the end of each financial year by transferring its balance to the profit and loss account.

Example

ABC company purchased a motor vehicle for $75,000 on 1 January 2016. The company plans to provide depreciation at 20% per year using the reducing installment method.

Required: Show the following accounts in the company's ledger for 2016, 2017, and 2018:

  • Motor vehicle account
  • Depreciation account
  • The relevant portion of the profit and loss account

Solution

Step 1: Calculation of depreciation for 2016, 2017, and 2018

For 2016:

  • Book value (original cost for the first year) at the beginning of 2016: $75,000
  • Depreciation for 2016: $75,000 × 0.2 = $15,000

For 2017:

  • Book value at the beginning of 2017: $75,000 – $15,000 = $50,000
  • Depreciation for 2017: $50,000 × 0.2 = $10,000

For 2018:

  • Book value at the beginning of 2018: $50,000 – $10,000 = $40,000
  • Depreciation for 2018: $40,000 × 0.2 = $8,000

Step 2: Prepare the ledger accounts

Motor Vehicle Account
Depreciation Expense Account

At the end of all three years, depreciation will appear on the debit side of the profit of loss account as an expense. It is shown below:

Accounting Treatment of Depreciation

Accounting Treatment of Depreciation FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.