Whether your business owns computers, cars or copiers, these assets lose value over time. You record the loss by reporting accumulated deprecation as an account on your balance sheet. Although depreciation lowers the value of your assets, it's not a liability but an asset account.
Accumulated depreciation is a contra asset account. If, say, you have $400,000 in accumulated depreciation, you don't owe anyone that money, so it's not a liability. Instead, you treat it as an asset account even though it's a negative figure.
Your company's fixed assets are things you bought to use rather than to resell that you expect to operate for more than one year. Printer paper isn't a fixed asset, for example, but the printer is. Fixed assets include buildings, computer equipment, land, computer software, furniture, machinery and vehicles.
When you buy a fixed asset, you record its value as the purchase price. Over time, most fixed assets lose value from damage due to impairment or from depreciation due to age. Every accounting period, you have to adjust the asset's book value accordingly.
Assets under a certain value, known as the capitalization limit, can be written off as an expense the year you buy them instead of being depreciated over time. Accounting practice lets you set the cap limit that works best for your company. You only count purchases as fixed assets if they cost more than the cap limit.
Suppose you buy $4,000 worth of computer equipment for your business. You record it as an asset in your journal and reduce your cash asset account by $4,000.
In accounting, computer equipment typically has a useful life of five years. You don't have to discard the equipment; useful life is simply an accounting concept you use to figure depreciation.
- After you know an asset's useful life, determine whether it has salvage value. If, say, your computers will be worth $500 at the end of five years, you subtract that salvage value from the purchase price to get $3,500.
- If you use straight-line depreciation, you'd depreciate a fifth of the purchase price less salvage value each year. The first year, for instance, you'd have a depreciation expense of $700 for the computers, reducing the book value to $2,800.
- You record $700 for the year in the journal account for depreciation expense. You also record $700 as an accumulated depreciation journal entry.
- At the end of the year, you report $700 as an expense on the income statement. You also report $700 of accumulated depreciation on your balance sheet.
You can use an accumulated depreciation calculator to simplify a lot of the math.
Some business owners are unsure whether depreciation is an asset or a liability. Even though it reduces the value of your assets, it's not a liability. Unlike a loan or an account payable, you don't owe accumulated depreciation to anyone.
Instead, depreciation is a contra asset account. Contra accounts contain negative amounts paired with regular asset accounts to reduce their value. The doubtful accounts contra account, for instance, reduces the value of your accounts receivable to reflect that some customers won't pay their debts.
Accumulated depreciation likewise reduces the value of fixed assets. After three years, your computer equipment's accumulated depreciation is $2,100, so the computers' value on your balance sheet is $1,900.
For an accumulated depreciation balance sheet example, suppose you've bought $15,000 worth of engineering equipment with a 10-year lifespan and no salvage value. The first year, your depreciation expense is $1,500, and you make an accumulated depreciation journal entry of $1,500 as well.
At the end of the year, you report the depreciation as an expense on the income statement and the accumulated depreciation as a contra asset on your balance sheet. The following year, you report another $1,500 in depreciation expense for the year, and accumulated depreciation increases to $3,000.
If after seven years you decide to retire the equipment and junk it, you wipe the value of the equipment from your fixed asset account. You also zero out the accumulated depreciation, as there's no longer anything to depreciate.