Everything You Should Know About Depreciation Journal Entry

A depreciation account is an account that is used to record the allocation of the cost of fixed or non-current financial assets over their remaining life or valuable life or their life expectancy. To better understand the process of recording depreciation entries, we first need to understand what depreciation journal entries mean. Depreciation is the process of allocating the cost of a long-term asset over its useful life. In accounting, a depreciation account is used to record the decrease in the value of an asset over time. 

Did you Know? Automobiles, electronic gadgets like smartphones, and laptops are among the most depreciating assets of all time. 

Overview of Depreciation Journal Entries

Accounting for depreciation requires keeping a record of many entries to convert the depreciation amount into an expense for the company. These entries are designed to reflect the use of assets in the company in financial terms. They might be designed to accommodate all different types of depreciating assets or may be subdivided into multiple entries to reflect all the different assets present in the company. Instead, it is considered an investment made for the company's benefit. 

How to Record a Depreciation Journal Entry? 

Journal entries for depreciation are made in many ways. But before understanding those methods, you need to get familiar with a few terms that will help you better understand concept.

1. Practical Life

The useful life of any asset is the period in which the asset remains functional and proves useful for the company. 

2. Salvage Value

In simple words, salvage value is the asset's selling price once its useful life has ended. It plays an instrumental role in determining the depreciation amount of the asset.

3. Book Value 

Book value is the value of an asset obtained after accounting for depreciation has been done. 

Also Read: What is Depreciation Under the Income Tax Act

Different Methods of Depreciation Journal Entries

Depreciation journal entries document the reduction in the financial value of the assets in the company.

1. Straight-Line Depreciation 

It is one of the easiest and simplest methods of making journal entries for depreciation. This method considers the depreciation amount to be the same throughout the asset's life. It creates a separate asset account, which is credited with the depreciation amount at the end of the year or month. This amount is included as an expense on the company account's balance sheet, i.e. shown as a debit on the company account.  

Once the asset has reached its end or more depreciation cannot be charged, we can safely say it has reached its scrap value. One of the disadvantages of this method is that it becomes impossible to track down the asset's original cost and find the total amount of depreciation. 

2. Provision for Depreciation or an Accumulated Depreciation Account 

The depreciation method is not directly credited to the asset account. Instead, a separate provision for depreciation is maintained and keeps a record of where the depreciated amount is maintained and in which the depreciation amount is credited. One of the major advantages of this method over the first is that we can get the original cost and depreciated values as both accounts are handled separately.  

3. Double-Declining Depreciation Method 

This method is most suitable for assets that lose a fair amount of their value at the very beginning of their life, for example, automobiles or smartphones. The method helps to include more depreciation in the beginning years of the asset's life. In this method, we calculate the depreciation amount at twice the rate and consider the asset's book value for calculating the depreciation amount in subsequent years. 

4. Sum-of-the-years Depreciation 

Unlike the above methods, which consider the original cost or the book value of the asset for the calculation of depreciation, this method considers the useful life of the asset to calculate the depreciation amount of the asset. Just like the double declining method, it is also best suited for assets that lose their value more in the year's beginning than in their upcoming years. 

5. Unit-based Depreciation Method 

Assets like printers or bottle-making machines work based on how many units they produce per day or hour, etc. The depreciation value of such assets needs to be calculated similarly. It includes the factor of how many units were produced during the asset's useful life.  

To better understand the different methods of depreciating entries, let us consider an example here:

Consider a company XYZ which invests an amount of ₹10,00,000 on the asset in the year 2022. This asset is going to function for a total of 20 years and is expected to have a salvage value of ₹1,00,000 at the end of its useful life. 

Also Read: Straight Line Method of Depreciation - Straight Line Depreciation Formula

Different Methods for Depreciation

Let us find out the depreciation amount by different methods. 

1. Straight Line Method 

The cost of the asset given is ₹10,00,000 and is expected to be used for 20 years and at the end, the salvage value is expected to be ₹1,00,000. So the depreciation amount simply becomes (₹10,00,000 - ₹1,00,000) / 20 = ₹45,000.

This is the depreciation amount that needs to be recorded for the next 10 years. It would look something like this on the balance sheet. 

A similar method can be used while preparing annual balance sheets in the future. 

2. Provision for Depreciation or the Accumulated Depreciation Method 

The only difference in the second method that comes into play is the depreciation amount is credited to a separate depreciation account instead of directly crediting it to the asset account. It would look something like this on the balance sheet:

3. Double-Declining Method 

The initial book value of the asset is the same as the cost of the asset. 

Therefore the depreciation amount for the first year can be calculated by 

(₹10,00,000)/20 x 2 = ₹1,00,000

For the next year, the depreciation value will be different as the book value will change.

The book value for next year will be (₹10,00,000 - ₹1,00,000) = ₹9,00,000

Thus the depreciation for the next financial year will be calculated on the book value of ₹9,00,000 and so on. 

4. Sum-of-the-years Depreciation Method 

The total useful life is 20 years. So just add them up 

(1 2 3 4 5 6…….. 20) = 210

Thus, the depreciation for the first year will be calculated as 

(₹10,00,000) x (20/210) = ₹95,238

Similarly, the calculation for the second year will be 

(₹10,00,000) x (19/210) = ₹90,476

5. Unit-based Depreciation Method 

Consider the asset purchased as a bottling machine which is expected to produce 20,00,000 units throughout its life. Therefore, the depreciation value for the first year will be calculated as 

(₹10,00,000 - ₹1,00,000) / 20,00,000 = ₹0.45

So if the bottle machine makes 1,00,000 units per year then the depreciation amount will be calculated as 

(1,00,000 x 0.45) = ₹45,000 for the first year

This amount will change yearly as it is based on machine usage per year. 

Now we have understood what a depreciation journal entry is and how it's done, we must understand why it's done and what is its relevance in today’s modern accounting methods. 

Also Read: Depreciation Rate as Per Companies Act Explained With How to Use the Depreciation Calculator?

The Importance of Depreciation Journal Entries

Whenever a depreciation journal entry is made, the company’s income also decreases by the same amount as the depreciation amount is included as an expense for the company. This helps many small-sized businesses and MSMEs reduce income tax and increase their profit margins. This helps the company recover their asset cost, which it paid during the acquisition.  

Conclusion 

Depreciation journal entries are the record of the depreciating amount of the various assets in a company. They are meant to be reflected on the company’s annual or monthly balance sheet. Even though most assets depreciate over time, there are still exceptions. Most of the land and property assets don’t depreciate. Also, there is no concept of life expectancy or useful life associated with such assets, so they are not considered depreciable. These differences come down to the method of depreciation adopted by the company, their evaluation of the market, etc.  
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