How to Calculate the Depreciation of Fixed Assets
If for example, a business has purchased furniture with a value of 4,000 and expects it to have a useful life of 4 years and a salvage value at the end of that time of zero, then the simple straight line depreciation of fixed assets would be calculated as follows:
In this example the depreciation expense is calculated as follows.
Depreciation expense = (Cost of asset - Salvage value) / Useful life Depreciation expense = (4,000 - 0) / 4 = 1,000
In this example the depreciation expense is 1,000 per year for the next 4 years.
Journal Entry for the Depreciation of Fixed Assets
The depreciation expense is calculated at the end of an accounting period and is entered as a journal as follows:
| Account | Debit | Credit |
|---|---|---|
| Depreciation expense | 1,000 | |
| Accumulated depreciation | 1,000 | |
| Total | 1,000 | 1,000 |
Depreciation of Fixed Assets Entries Explained
Debit
Profits, which belonged to the owners of the business, have been set aside and retained within the business to pay for replacement fixed assets.
Credit
The accumulated depreciation account is established to record the ‘liability’ of the business to pay for replacement fixed assets in the future.
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the owners equity in the business. This is true at any time and applies to each transaction. For this transaction the Accounting equation is shown in the following table.
| Assets | = | Liabilities | + | Owners Equity |
|---|---|---|---|---|
| Fixed Assets | = | None | + | Retained earnings |
| – 1,000 | = | 0 | + | -1000 |
The credit entry to the accumulated depreciation account (a contra asset account), causes the net book value of the fixed assets to be reduced.
The debit to the depreciation expense will reduce the net income and retained earnings of the business resulting in a decrease in the owners equity.
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About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.