Depreciation Journal Entry

Depreciation is one of the adjusting entries made at the end of every period. The entry itself is always the same two lines. What takes care is the amount, and what happens when the asset is eventually sold. This guide covers the annual entry, the monthly entry and the sale of equipment, using one worked example throughout.

What the depreciation entry records

When a business buys equipment, it records the cost as an asset. The equipment will be used for several years, so its cost is spread over those years as an expense. Each period's share is depreciation.

Depreciation doesn't involve any cash. The cash left when the equipment was bought. The entry simply moves part of the cost from the balance sheet to the income statement, so each period carries a fair share of the cost of the equipment it used. That is why it is an adjusting entry: it is made at the end of the period to bring the accounts up to date, not because a transaction happened that day.

The entry and why it uses a contra account

The depreciation entry always has the same shape:

Depreciation Expense is an expense, so a debit increases it. It appears on the income statement and reduces profit.

Accumulated Depreciation is a contra-asset account. It sits on the balance sheet next to the equipment and carries a credit balance that grows each period. The equipment account keeps showing the original cost, and the two together show the book value:

Book value = cost − accumulated depreciation

Why not just credit the Equipment account? Because the original cost is useful information. Readers of the balance sheet can see what the business paid and how much of it has been used up. The contra account keeps both numbers visible.

Worked example: Harbor Bakery's riding mower

Harbor Bakery owns a riding mower that cost $31,750.00. It expects to use it for 5 years and then sell it for about $2,850.00, its salvage value. Harbor Bakery uses the straight-line method, which charges the same amount every year.

Step 1: work out the annual amount

Straight-line depreciation is cost minus salvage value, divided by the useful life:

($31,750.00 − $2,850.00) ÷ 5 = $28,900.00 ÷ 5 = $5,780.00 a year.

The salvage value is subtracted first because the business expects to get that part back. Only the part it will use up becomes expense.

Step 2: record one year of depreciation

After this entry, the mower's book value is $31,750.00 − $5,780.00 = $25,970.00. The Equipment account still shows $31,750.00.

How the accounts move over the mower's life

Harbor Bakery makes the same entry at the end of each of the five years. Depreciation Expense starts again at zero every year, because it is closed out with the other expenses. Accumulated Depreciation is a balance-sheet account, so it keeps growing:

At the end of year 5, the book value equals the $2,850.00 salvage value. That is the point of subtracting salvage at the start: the mower is depreciated down to what the bakery expects to get for it, and no further. If the bakery keeps using the mower after year 5, it records no more depreciation.

On the balance sheet at the end of year 2, the mower would be shown like this: Equipment $31,750.00, less Accumulated Depreciation $11,560.00, giving a net book value of $20,190.00.

Step 3: record one month instead

Many businesses close their books every month, so they record depreciation monthly. Take the annual amount and divide by 12: $5,780.00 ÷ 12 = $481.666…, which rounds to $481.67.

Other methods use the same entry

Straight-line is not the only way to calculate depreciation. Accelerated methods, such as double-declining balance and sum-of-the-years' digits, put more of the cost in the early years. For Harbor Bakery's mower, sum-of-the-years' digits would give $9,633.33 in year 1 instead of $5,780.00.

The method only changes the amount. The entry is still a debit to Depreciation Expense and a credit to Accumulated Depreciation. So once you know the entry, every new method is just a new calculation. The same goes for assets bought partway through a year: the business works out the share of the year that applies, under its own policy, and records that amount with the same two lines.

Recording the sale of equipment

Eventually the asset is sold or scrapped. At that point, everything about it comes off the books: its cost and its accumulated depreciation. Whatever cash is received is compared with the book value, and the difference is a gain or a loss.

• If the price is more than book value, the difference is a gain (a credit).
• If the price is less than book value, the difference is a loss (a debit).

Before recording a sale, bring depreciation up to the date of sale. Otherwise the book value, and therefore the gain or loss, is wrong.

Worked example: Summit Bike Repair's printing press

Summit Bike Repair sold its printing press for $7,800.00 in cash. The press cost $20,750.00, and three years of depreciation, $9,549.99 in total, have been recorded on it.

First, the book value: $20,750.00 − $9,549.99 = $11,200.01.

Next, compare: the price of $7,800.00 is less than the book value of $11,200.01, so there is a loss of $11,200.01 − $7,800.00 = $3,400.01.

Now the entry. Cash comes in (debit). The accumulated depreciation is removed, and because it has a credit balance, removing it takes a debit. The equipment's cost is removed with a credit. The loss is the debit that makes the entry balance.

Debits and credits both total $20,750.00. After the entry, the Equipment and Accumulated Depreciation accounts show nothing for the press, which is right: the business no longer owns it.

Had the press sold for more than $11,200.01, the last line would instead be a credit to Gain on Sale of Equipment for the difference.

Common mistakes

These are the mistakes the exercises check for. Each one leaves an account with the wrong balance, even when the entry itself balances.

Ignoring the salvage value

Dividing the full cost by the life gives $31,750.00 ÷ 5 = $6,350.00 a year instead of $5,780.00. Over five years the mower would be depreciated to zero, even though Harbor Bakery expects to sell it for $2,850.00. Subtract the salvage value first.

Crediting the Equipment account

Crediting Equipment instead of Accumulated Depreciation gets the book value right but loses the original cost. After one year the Equipment account would show $25,970.00, and no one could tell what the mower cost. Always credit Accumulated Depreciation and leave the asset at cost.

Recording a full year in a monthly close

When the books close monthly, each month carries one twelfth of the year's depreciation. Recording $5,780.00 in a single month overstates that month's expense by $5,298.33 and makes profit look much lower than it was. Divide by 12.

Leaving accumulated depreciation on the books after a sale

If you only remove the cost, you are comparing the price with the original $20,750.00 instead of the book value. Summit Bike Repair would record a loss of $12,950.00 rather than $3,400.01, and Accumulated Depreciation would keep a $9,549.99 balance for a press the business no longer owns. Debit Accumulated Depreciation to clear it.

Putting every line on the opposite side

Swapping all the debits and credits still balances, which is why it slips through. Read each line as a sentence: "Cash went up by $7,800.00" must be a debit; "Equipment went down by $20,750.00" must be a credit.

How to check your entries

• Debits equal credits. Add both columns.
• Equipment stays at cost until the asset is sold.
• Book value never drops below salvage value. If it does, depreciation has run too long or salvage was ignored.
• After a sale, both accounts are clear for that asset: no cost and no accumulated depreciation left.

Related topics

To calculate depreciation for every year of an asset's life, including the double-declining balance and sum-of-the-years' digits methods, see depreciation schedule in Excel. It uses the same Harbor Bakery mower, so the $5,780.00 figure appears there too. For the other end-of-period entries, start with adjusting entries practice, then accrued expenses.