Double Entry for Depreciation

Introduction:

This note will discuss how to record depreciation using the double-entry system of bookkeeping. The note will highlight the accounts that are affected upon depreciation and how to record transactions in those assets.

Essence of Recording Depreciation:

When our assets are losing value due to depreciation, it is important to record such a loss of value. Among others, this ensures that:

1. The financial statements reflect the true value of our assets over time, thereby preventing overstatement of profits and the value of our assets. If the loss in the value of assets is not recorded, we will still deal with the assets as if they have lost no value. Note that calculating depreciation using any of the methods is one thing; making the calculations reflect is another.

2. Depreciation is in the form of an expense. You may think of it as costs incurred in using our assets to generate revenue. For instance, if a vehicle is used to transport goods, its value decreases with each trip. This loss in value is an expense associated with transporting the goods. In light of this, recording depreciation is essentially recording an expense in our books. More importantly, such recording aligns with what is known as the matching concept in accounting, which advances that expenses should be recognised in the period in which they are incurred. By using any of the methods of depreciation, we get the depreciation expense for a particular year and record it, ensuring compliance with the matching principle.

3. By recording depreciation as an expense, we can deduct it from assessable income to get chargeable income, thereby reducing our tax liability.

Accounts Affected in Recording Depreciation:

When making a double entry for depreciation, the following four accounts are often affected.

i. Assets account

ii. Disposal of asset account

iii. Provision for depreciation account

iv. An extract of the profit and loss account or income statement.

These are now discussed.

1. Assets Account:

A. Description:

This is an account for the fixed asset that is affected by the depreciation. It may be furniture, equipment, or other assets. The name of the asset account will reflect the type of asset we are dealing with. For instance, if we are dealing with furniture and the depreciation affecting furniture, the name of the asset account will be “Furniture”.

B. Nature of Recordings upon Acquisition and Disposal of an Asset:

An asset account is typically affected when one of the following two transactions happens:

i. Acquisition of an asset.

ii. Disposal of an asset.

Upon an acquisition of an asset, the asset account is debited with the cost of the asset, and a cash, bank, or supplier’s account is simultaneously credited with the cost of the asset. This debit entry increases the overall value of assets in the business.

Upon the disposal (sale) of an asset, we need to reduce the value of our total assets by the same value for which it was acquired. To do this, we credit the asset account with the cost price of the asset (note that you are not subtracting depreciation from the asset at this point). The account in respect of which the asset account is credited is the Asset Disposal Account.

2. Asset Disposal Account:

A. Description:

This is an account used to record the disposal of fixed assets. By “disposal,” we are referring to the sale of fixed assets.

It is also an account where the following are recorded:

i. All the depreciation that affects the disposed asset

ii. Profits and losses upon the disposal.

B. Nature of Recordings Upon Disposal of an Asset:

Step One: Reduce Value of Assets by Cost of Disposed Asset:

Debit : Asset Disposal Account with the cost of the asset.

Credit : Asset Account with the cost of the asset.

Step Two: Remove the Accumulated Depreciation on the Disposed Asset:

Debit: Provision for Depreciation Account on [Insert Asset Name].

Credit: Disposal Account with the total/accumulated depreciation on the asset.

So if an asset was bought for Ghc 100,000 with a residual value of Ghc 70,000, the amount of Ghc 100,000 is first debited to the disposal account, and then the depreciation of Ghc 30,000 is credited to that same account in respect of the Provision for Depreciation Account.

Step Three: Record the Sales Proceeds:

Debit: Cash Account or Bank Account with the amount for which the asset was sold.

Credit: Disposal Account with the amount for which the asset was sold.

This is because upon the disposal, money is received in cash or through the bank, and this needs to be recorded.

Step Four: Calculate and Record Profit or Loss Upon Disposal:

We must decide if a profit or loss was made upon the disposal and then either make a debit entry if a profit was made, and a credit entry if a loss was made.

The following rules are applicable in determining whether a profit or a loss was made:

1. When a Profit can be said to have been Made: If the accumulated depreciation plus the amount received upon disposal of the asset (thus the sum of the credit side) exceeds the cost of the asset that exists on the debit side, a profit is made. The rationale is that the asset was acquired for an amount, lost value due to depreciation, but still sold at an amount that is higher than its post-depreciation value. To illustrate, imagine an asset was bought for Ghc 10,000 and had an accumulated depreciation of Ghc 4,000. This means it is only worth Ghc 6,000. If the facts show that the asset was resold for Ghc 7,000, it would have sold for Ghc 1,000 more than its post-depreciation value. The Ghc 1,000 is a profit. If you were to add the accumulated depreciation of Ghc 4,000 to the sale price of Ghc 7,000, and subtract the cost price of Ghc 10,000, you would still get Ghc 1,000. This profit of Ghc 1,000 will be recorded as a debit “Profit and Loss” entry in the Disposal account.
2. When a Loss can be said to have been Made: If the cost of the asset on the debit side exceeds the accumulated depreciation plus the amount received upon sale, there will be a loss. The loss is recorded as a debit “Profit and Loss” entry in the Disposal account.
3. When there is break even: Here, the debit side of the disposal account is equal to its credit side.

The above could be summarized as follows:

1. Profit: Sale Proceeds > (Cost - Accumulated Depreciation)
2. Loss: Sale Proceeds < (Cost - Accumulated Depreciation)
3. Break-even: Sale Proceeds = (Cost - Accumulated Depreciation)

3. Provision for Depreciation Account on Asset Account:

A. Description:

This is an account used to record the depreciation for an asset. You open this account for each fixed asset. Thus, if the business has furniture and equipment, you will have a provision for depreciation on the furniture account and another provision for depreciation on the equipment account.

B. Nature of Recordings Upon Disposal of an Asset and at the End of the Year:

i. Upon disposal of a fixed asset, the provision for depreciation account is debited with the accumulated depreciation on the fixed asset (and a corresponding credit entry is made in the disposal of asset account). This debit entry is simply a way of removing the accumulated depreciation of the asset that is disposed off. So if there are two motor vehicles, and accumulated depreciation on each is Ghc 10,000, we will have a total depreciation of Ghc 20,000 on the credit side of the provision for depreciation on motor vehicle account. Upon disposal of one of the motor vehicles, a debit entry of Ghc 10,000 removes the accumulated depreciation from the total accumulated depreciation of Ghc 20,000.

ii. At the end of the year, a credit entry is made to this account in respect of the profit and loss account. The amount that is credited is the same amount as the depreciation for the year.

4. An Extract of Profit and Loss Account or Income Statement Account:

This is an extract to show the various entries that were made in the provision for depreciation account and in the disposal of asset account.

In creating this account, the focus is to simply show the annual provisions for depreciation and the profit or loss that was made upon disposal of the asset.

In the income statement, the annual provisions for depreciation are treated as an expense. A profit on the disposal of the asset is treated as other income and recorded on the credit side. A loss made on disposal is recorded on the debit side.

In creating this, we may use a vertical or horizontal format.

Practical Examples:

MyGSL Ltd. acquired furniture for Ghc 30,000 cash on 1st January, 2010. It has an estimated useful life of 5 years and is estimated to be resold in 2015 for Ghc 10,000. On 31st December 2014, it was resold for Ghc15,000.

You are required to calculate the provision for depreciation using the straight-line method and record the transactions in the relevant books of MyGSL Ltd.

Solution:

Annual depreciation = (Cost – Residual Value) ÷ Estimated Useful Life.

Cost = Ghc 30,000.

Residual Value = Ghc 10,000.

Estimated Useful Life = 5 years.

Annual depreciation = (30,000 – 10,000) ÷ 5 = 20,000 ÷ 5 = Ghc 4,000.