Depreciation of fixed assets contains the cost of fixed assets in the cost of the goods or services produced. In accounting postings, depreciation of fixed assets is recorded on Journal Entry for Depreciation. Depreciation allows the manufacturer to include all production costs in the production price. In fact, due to depreciation, capital turnover occurs. Depreciation can only be terminated if the equipment is idle for more than three months and if the facilities are upgraded for 12 months or more. The amounts are accrued from the month following the month of putting the object into production and are not accrued from the month following the removal of the equipment from the output.
What is depreciation?
The depreciation of fixed assets is intended to summarize information on the depreciation of fixed assets owned by the enterprise and leased by it. The economic significance of depreciation lies in the gradual transfer of the object’s value to the price of the end product (service or work). In other words, this is the monetary expression of the depreciation of fixed assets. In accounting, the repayment of the property’s value is carried out concerning all objects, except excluded ones. Depreciation is understood as the depreciation of property, expressed in monetary terms, that occurs in the process of its use.
Plant and machinery, buildings, vehicles, furniture, and other assets that are expected to last more than one year but not indefinitely are subject to depreciation. Depreciation is assumed to be charged directly to the asset account in the journal entry. After you’ve computed depreciation, you’ll need to write down the expense as a journal entry. It is used to record depreciation expenses for a specific accounting period and can be manually entered into a ledger or entered into your accounting program.
There are several types of depreciation, and each of them has its pros and cons:
- linear way;
- reducing balance method;
- accrual of the amount, depending on the performance of the object;
- accrual of the amount, depending on the life of the thing.
Why is depreciation necessary?
It is a fundamental process, thanks to which the funds spent on the purchase are returned as part of the proceeds from the sale of manufactured products. Every month, depreciation deductions are calculated and written off to the cost of products, works, services, or sales expenses (to trade enterprises). Therefore, when a product goes on sale, its price includes a part of the cost of fixed assets used in the production process in the amount of depreciation. These funds are returned to the enterprise after the sale of products (works, services) and receipt of payment from the buyer. The funds received can improve existing fixed assets (repair, reconstruction, modernization) or purchase new, more modern facilities.
Depreciation of property, plant and equipment depreciation hangs on the asset’s useful life. This period is set by the enterprise independently, depending on the object type. In this case, you need to be guided by the classification of fixed assets, according to which all objects are divided into depreciation groups. Upon receipt of a fixed asset, the organization, following the type, determines which group the received fixed asset belongs to, selects the useful life corresponding to this group, and, based on it, calculates depreciation every month.
Accounting Journal Entry for Depreciation
The Journal Entry for Depreciation can be an entry for accounting for all types of fixed assets and can also be divided into separate entries to each type of fixed asset. The purpose of the critical access is to debit the depreciation expense account (which appears in the income statement) and credit the accumulated depreciation account (which appears in the balance sheet as a contra account, which is observed in the number of fixed assets).
After a specific time has passed, accumulated depreciation will continue to increase. It is because it does not equal the partial loss of activity. At this time, stop recording any depreciation expense as the asset’s value is now reduced to zero.
Relevance and usefulness
Depreciation is an essential key point. It is the indicator that is relevant to assets that are capitalized. Nevertheless, it is necessary to keep in mind that when the depreciation expenses are recorded in the financial statements, the same amount reduces the net income of the respective company. However, the Journal Entry for Depreciation has no impact on the company’s financial reserves because depreciation remains an unreliable item.
An equally important aspect of depreciation to keep in mind is that it is an estimate based on the cost of an asset (rather than replacement cost). A common misconception among many is that depreciation is a method of writing off a capitalized asset over time. However, the depreciation process evaluates a capitalized asset over time due to good use, depreciation of new machinery, or unfortunate conditions. The depreciation expense account is an essential point in assessing an asset’s present value or book value.
On the other hand, a rental property located in a developing area may have a market value over the outstanding amount shown on the balance sheet. There is a difference in the depreciation method adopted by the market and the company.
Unlike materials and inventories consumed in production, fixed assets gradually transfer their value to the company’s expenses. This process is called depreciation. However, when talking about certain types of fixed assets, it is not charged. Such objects include investments that do not change production qualities in the enterprise’s activities: land plots, cultural heritage sites, art collections, etc.
Depreciation entries in accounting are a way of recording the gradual depreciation of fixed assets in double-entry accounting. The expensive equipment acquired by the organization, transport, and even real estate cannot be attributed to costs immediately to avoid losses. Since it has been used for a long time, its price is written off as expenses in installments.
Author: Charles Lutwidge