Is Depreciation Expense Debit or Credit?
Is depreciation expense debit or credit? When companies purchase assets for their business, they try to consider how long these assets would keep their value and how to account for their expense. A depreciation expense is usually recorded for fixed assets and is the cost of the asset over time. For budgeting purposes, this depreciation expense calculation helps businesses determine and forecast the financial status of the related fixed asset.
When accounting for depreciation, is depreciation expense a debit or credit? In this article, we will discuss depreciation expense and its journal entry to ascertain whether depreciation expense is a debit or credit.
Related: Unearned service revenue debit or credit?
What is depreciation expense?
Depreciation expenses are the allocated portion of the cost of a company’s fixed assets for a certain period which is recognized on the income statement. It is recorded as a non-cash expense that reduces the company’s net income or profit. It is said to be a non-cash expense because the recurring monthly depreciation entry does not involve a cash transaction. As regards this, the statement of cash flows prepared under the indirect method adds the depreciation expense back to calculate the cash flow from operations.
Depreciation expense is an expense and is therefore treated as an expense account, but unlike most expenses, there is no related cash outflow. When the asset was originally purchased, the company had a net cash outflow in the entire amount of the purchased asset, so over time, there is no further cash-related activity. Hence, as an expense, depreciation is recorded on the income statement to represent how much of an asset’s value has been used up for that year.
Tracking an asset’s depreciation expense is important for reporting purposes. This is because it spreads the cost of the asset over the time it is in use. Hence, there are basically four methods that are used to calculate depreciation, they include straight-line method, declining balance method, sum-of-the-years’ digits method, and units of production. The straight-line method is the simplest way to calculate depreciation expense and the formula for this is:
(Cost of an asset – Salvage value) / asset’s useful life
The cost of an asset is the purchase price of the asset and the salvage value is the estimated book value of the asset after depreciation is complete. This salvage value is based on what a company expects to receive in exchange for the asset at the end of its useful life.
Let’s look at an example to explain this further. Assume a company spent $50,000 on a piece of equipment for long-term use in its operations. Say, the company estimates that the salvage value will be $2,000 and the asset’s useful life, is 15 years. The depreciation expense per year would be calculated as follows:
(Cost of an asset – Salvage value) / asset’s useful life
=($50,000 – $2,000)/15
= $3,200
For accounting purposes, this calculated depreciation is recorded in the depreciation expense account and must be reported in another account which is the accumulated depreciation account. The accumulated depreciation account shows the total depreciation expense since the time that the asset has been in use. This means that, if the asset has been used for five years, the accumulated depreciation would be calculated as:
The depreciation expense per year x 5 years
= $3,200 x 5
= $16,000
Accounting for depreciation expense
Accounting for depreciation expense requires a continuing series of entries to charge a fixed asset to expense, and eventually to devalue the asset. These entries are done to reflect the ongoing usage of fixed assets over time. Hence, depreciation is the gradual charging to the expense account of an asset’s cost over its expected useful life. The essence of using depreciation to gradually reduce the recorded cost of a fixed asset is to recognize a portion of the asset’s expense at the same time that the business records the revenue that was generated from the use of the fixed asset.
This is because it would be an improper accounting transaction under the matching principle to charge the cost of an entire fixed asset to expense in a single accounting period when the fixed asset keeps generating revenues for years into the future. It is said to be an improper accounting transaction because revenues are not being matched with the related expenses which go against the accounting matching principle. The accounting matching principle requires that a business records its expenses alongside revenues earned.
Revenues in reality cannot always be directly associated with a specific fixed asset but can easily be associated with an entire system of production or a group of assets, like a production line. Hence, as revenue is earned, the cost of the fixed assets is charged to expense as depreciation expense in order to match the related revenues and expenses in the same period.
Conclusively, over the course of a company’s fiscal year, the balance in the depreciation expense account increases and is then flushed out and set to zero. The balance is zeroed out as part of the year-end closing process. Then, the account is used again to store depreciation charges in the next fiscal year.
Now, that we have an understanding of depreciation expense, is it recorded as a debit or credit? Let us look at what accounts are entered as debit and credit entries in the double-entry system to answer this question.
Related: Salaries expense debit or credit?
The double entry system (debit and credit)
The debit and credit are entries in a double-entry system that are made in account ledgers to account for the changes in value that result from business transactions. A credit entry would always add a negative number to the journal while a debit entry would add a positive number to the journal. Therefore, a debit will always be positioned on the left-hand side of the ledger whereas a credit will always be positioned on the right-hand side of the ledger.
Credits will cause an increase to some accounts such as the revenue, equity, and liability accounts while accounts like the expense and asset accounts will decrease by a credit entry. Debits, on the other hand, cause the balance of accounts such as the expense and asset accounts to increase while reducing accounts like liability, equity, and revenue accounts.
In accounting, the numbers from business transactions are recorded in at least two accounts, either as a debit or as a credit. For instance, when an entry to record depreciation is made to the depreciation expense account, there must be an offsetting entry to another account. This is why when an amount is recorded in the depreciation expense account as a debit, an offsetting credit entry of the same amount is made to the accumulated depreciation account. This accumulated depreciation account is a contra-asset account that offsets the fixed asset account.
Since we know that depreciation expense is an expense account, and debit entries will cause the balance of expense and asset accounts to increase; does it mean depreciation expense is a debit and not a credit? We will discuss this further.
See also: Is Purchase Debit or Credit?
Is depreciation expense debit or credit?
The depreciation expense recorded flows through to the income statement in the period that it is recorded. Whereas the accumulated depreciation of which the offsetting entry is made is presented on the balance sheet below the line for related capitalized assets. The balance of the accumulated depreciation increases over time, as the amount of depreciation expense recorded in the current period, is added.
Hence, the journal entry for depreciation is a debit to the income statement account- Depreciation Expense and a credit to the balance sheet account- Accumulated Depreciation. Depreciation Expense is a temporary account and as such is reported on the income statement. As a temporary account, at the end of each year, its balance is closed and the Depreciation Expense account begins the next year with a zero balance.
The Accumulated Depreciation account on the other hand is a permanent account and as such is a balance sheet account. Hence, its balance is not closed at the end of the year. Accumulated depreciation is a contra-asset account whose credit balance gets larger every year. Its credit balance, however, cannot exceed depreciation expense which is the cost of the asset being depreciated.
The purpose of the debit journal entry for depreciation expense is to achieve the matching principle. Therefore, in each accounting period, part of the cost of certain fixed assets will be moved from the balance sheet to depreciation expense on the income statement. The essence is to match the cost of the asset (depreciation expense) to the revenues in the accounting periods in which the asset is being used.
Journal entry for depreciation expense
The journal entry for depreciation expense is a debit entry because it is an expense. All expenses and assets have a natural debit balance. As earlier said the offset to the depreciation expense debit entry would be a credit to the accumulated depreciation account (which is a contra-asset account). A contra-asset account has a contrary entry to the natural debit balance of the asset account.
That is, the correct depreciation journal entry would be to record the current depreciation amount as a debit to the Depreciation expense account and as a credit entry to the Accumulated depreciation account to offset the debit entry. That is:
Debit and credit journal entry for depreciation expense
| Account name | Account type | Debit | Credit |
|---|---|---|---|
| Depreciation expense | Expense | 00 | |
| Accumulated depreciation | Contra asset | 00 |
As shown in the journal entry above, depreciation is an expense account and as such would have a natural debit balance. This account records the amount of depreciation for one single accounting period. The Accumulated depreciation, on the other hand, is a contra-asset account and as such would have a natural credit balance (that offsets the natural debit balance of fixed assets). This account carries the total cumulative amount of asset depreciation charged to date (aggregates the amount of depreciation expense charged against the fixed asset).
Each year, the depreciation expense account is debited by the calculated depreciation amount, expensing a portion of the asset for that year, while the accumulated depreciation account is credited for the same amount. Over the years, as the depreciation expense is charged against the value of the fixed asset, the accumulated depreciation increases.
See also: Rent expense debit or credit?
Why depreciation expense is a debit and not a credit
Recall that, debits cause an increase in expense and asset accounts while reducing liability, equity, and revenue accounts whereas credits cause an increase in revenue accounts, equity, and liability accounts while decreasing expense and asset accounts.
Expenses cause the owner’s equity to decrease and as such should have a debit balance because the normal balance of owner’s equity is a credit balance. Hence, an expense must be recorded as a debit. In accordance with this, depreciation expense as an expense will be recorded as a debit and not a credit.
At the end of the accounting year, the debit balances in the expense account will be closed and transferred to the owner’s capital account or retained earnings (stockholders’ equity account), thereby reducing equity. Also, expenses increase with a debit entry, thus, in order to increase a depreciation expense account, it has to be debited.
Related: Utilities Expense Debit or Credit?
Examples of depreciation expense: debit and credit journal entries
As explained earlier, depreciation expense is a debit and not a credit entry. Let’s look at some examples to show how depreciation expense is a debit and not a credit.
Debit and credit journal entry for depreciation expense on PP&E (Property, plant & equipment)
Assume a company, ABC Ltd, has a property, plant & equipment account. Using the straight-line method, the company charges depreciation of $1,000,000 in the books of accounts every year. At the beginning of the accounting year 2021, the balance of the Property, Plant & Equipment account was $7,000,000, and the balance of the accumulated depreciation account was $3,000,000. Assuming during the year, ABC Ltd made no purchases and sales concerning its property, plant & equipment.
What will be the correct journal entry in the company’s books of accounts to record the depreciation expense and accumulated depreciation at the end of the accounting year 2021?
Solution
From the straight-line method used, the company’s depreciation expense for the current year is $1,000,000. In the current year 2021, the company made no purchases and sales concerning its property, plant, and equipment. Therefore, no adjustments are required to be made. This means that at the end of the accounting year entry, the depreciation and accumulated depreciation will be recorded as:
Debit and credit journal entry for depreciation expense of $1,000,000 recorded for the current year
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 31/12/2021 | Depreciation Expense A/c | $1,000,000 | |
| To Accumulated depreciation A/c | $1,000,000 |
Debit and credit journal entry for depreciation expense on a vehicle
A construction company bought a car for making deliveries and picking up new supplies. The car cost $5,000 and its useful life is 5 years. The owner of the company, Mr. Peter expects the salvage value of the car to be zero and calculates the depreciation expense as:
(Cost of an asset – Salvage value) / asset’s useful life
= ($5,000 – 0)/5
= $1,000
This means that the car is depreciated at a rate of $1,000 per year. At the end of each year, Mr. Peter will record this depreciation expense journal entry:
Debit and credit journal entry for depreciation expense of $1,000 recorded for the car
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 31/12/2022 | Depreciation Expense A/c | $1,000 | |
| To Accumulated depreciation A/c | $1,000 |
Debit and credit journal entry for depreciation expense on fixed assets
Company XYZ calculates that it should have a $25,000 depreciation expense on its assets in the current month. Hence, the entry is made as:
Debit and credit journal entry for depreciation expense of $25,000 recorded for fixed assets
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 31/01/2022 | Depreciation Expense A/c | $25,000 | |
| To Accumulated depreciation A/c | $25,000 |
In the following month, Company XYZ’s controller decides to show a higher level of precision at the expense account level and opts to share the $25,000 depreciation expense across different expense accounts, so that each class of fixed asset has a separate depreciation charge. This entry would look like this:
Debit and credit journal entry for depreciation expense of $25,000 shared across different expense accounts
| Date | Account | Debit | Credit |
|---|---|---|---|
| 28/02/2022 | Depreciation expense: Automobiles | $3,000 | |
| Depreciation expense: Software | $2,000 | ||
| Depreciation expense: Furniture & Fixtures | $9,000 | ||
| Depreciation expense: Computer equipment | $5,000 | ||
| Depreciation expense: Office equipment | $6,000 | ||
| Accumulated depreciation | $25,000 |
Journal entry for depreciation expense on machinery
Mr. John purchases a piece of machinery for $3,900 and determines its salvage value to be $1,000. If the machinery’s useful life is three years, what will be the depreciation expense if Mr. John is recording depreciation monthly? Make a journal entry for this.
Solution
The depreciation expense would be:
($3,900 – $1,000)/3
= $966.67
This means that $966.67 is the annual depreciation expense figure. In order to record the depreciation expense that will be recorded monthly, we will have to divide our annual depreciation expense by 12 months. That is:
= $966.67/12 months
= $80.56
This means that $80.56 will be the monthly depreciation expense throughout the life of the machinery. In order to record this depreciation expense amount, the journal entries below will be made:
Debit and credit journal entry to record the purchase of machinery
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 01/06/2022 | Fixed Assets – Machinery | $3,900 | |
| Cash | $3,900 |
Debit and credit journal entry to record monthly depreciation expense of $80.56 recorded on machinery
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 30/06/2022 | Depreciation Expense A/c | $80.56 | |
| To Accumulated depreciation A/c | $80.56 |
Debit and credit journal entry for depreciation expense on building
Assume that ABC company had paid $480,000 for its office building (excluding land). Say this building has an estimated useful life of 40 years (which is 480 months) with no salvage value. Using the straight-line method of depreciation, calculate the depreciation expense to be reported on each of the company’s monthly income statements and show the journal entry for this.
Solution
(Cost of an asset – Salvage value) / asset’s useful life
($480,000 – 0)/480 months
=$1,000
This means that the monthly depreciation expense that will be recorded will be $1,000. The journal entry will be:
Debit and credit journal entry for monthly depreciation expense of $1,000 recorded on office building
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 01/01/2022 | Depreciation Expense A/c | $1,000 | |
| To Accumulated depreciation A/c | $1,000 |
