The asset’s cost minus its estimated salvage value is known as the asset’s depreciable cost. It is the depreciable cost that is systematically allocated to expense during the asset’s useful life. To illustrate the cost of an asset, assume that a company paid $10,000 to purchase used equipment located 200 miles away. The company then paid $2,000 to transport the equipment to its location.
In our example, the first year’s double-declining-balance depreciation expense would be $58,000 × 40%, or $23,200. For the remaining years, the double-declining percentage is multiplied by the remaining book value of the asset. Kenzie would continue to depreciate the asset until the book value and the estimated salvage value are the same (in this case $10,000). Applying this to Liam’s silk-screening business, we learn that he purchased his silk-screening machine for $5,000 by paying $1,000 cash and the remainder in a note payable over five years. Following GAAP and the expense recognition principle, the depreciation expense is recognized over the asset’s estimated useful life. Depreciation expense is recorded on the income statement as an expense and represents how much of an asset’s value has been used up for that year.
Since the asset has been depreciated to its salvage value at the end of year four, no depreciation can be taken in year five. We also address some of the terminology used in depreciation determination that you want to familiarize yourself with. Finally, in terms of allocating the costs, there are alternatives that are available to the company. We consider three of the most popular options, the straight-line method, the units-of-production method, and the double-declining-balance method. If an asset is sold or disposed of, the asset’s accumulated depreciation is removed from the balance sheet.
Net book value isn’t necessarily reflective of the market value of an asset. Accumulated depreciation is used to calculate an asset’s net book value, which is the value of an asset carried on the balance sheet. The formula for net book value is cost an asset minus accumulated depreciation.
Suppose your company owns a single building that you bought for $1,000,000. Under US GAAP, this is how this building would appear in the balance sheet. Even if the fair value of the building is $875,000, the building would still appear on the balance sheet at its depreciated historical cost of $800,000 under US GAAP. Alternatively, if the company used IFRS and elected to carry real estate on the balance sheet at fair value, the building would appear on the company’s balance sheet at its new fair value of $875,000. However, both pertain to the “wearing out” of equipment, machinery, or another asset. They help state the true value for the asset; an important consideration when making year-end tax deductions and when a company is being sold.
We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.
The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Accumulated depreciation is a running total of depreciation expense for an asset that is recorded on the balance sheet. An asset’s original value is adjusted during each fiscal year the contra account used to record depreciation is depreciation to reflect a current, depreciated value. Accumulated Depreciation is a contra asset that pairs with Fixed Assets. Accumulated Depreciation acts as a subaccount for tracking the ongoing depreciation of an asset. A Fixed Asset is a Long-term Asset used by a company to create revenue.
For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. Therefore, the asset’s net value (or the book value) will be $70,000. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. The difference between the debit balance in the asset account Truck and credit balance in Accumulated Depreciation – Truck is known as the truck’s book value or carrying value.
