What are The Journal Entries for Depreciation

Introduction to Depreciation

Depreciation charges are a way of spreading the cost of a capital/fixed asset over its useful life.

When a company makes a purchase of an item that will provide a long term benefit to the business (a delivery van, for example) it wouldn’t be fair to just put one large expense through the profit and loss account. This is because although the expense was incurred only once and in one accounting period, the van may be used for years to come. Therefore, we use depreciation to spread the expense of the capital purchase over the useful life of the asset.

Once the useful life of the asset has been calculated, working out the journals to be posted for depreciation is a very simple process.

Example

Let’s say we have purchased a delivery van worth £10,000 and we know that this van will have a useful life of 10 years. We simply divide the £10,000 cost by 10 to get the annual depreciation charge for the van.

£10,000 / 10 = £1,000 per annum.

Most businesses will put through a monthly depreciation journal so we will take a further step of dividing the annual charge by 12 to get the monthly amount.

£1,000 / 12  = £83.33 per month

Now we have calculated the value of the monthly amount we can work out the journal entries:

Depreciation charges affect both the balance sheet (reducing the book value of the asset) and the profit and loss account (the expense each month). One important thing to understand about the balance sheet side of depreciation is that it doesn’t directly reduce the cost price of the asset in the balance sheet. Instead, the monthly charges build up in an “accumulated depreciation” account which gets offset against the original cost price of the asset. Assets are stated on the balance sheet at their “net book value” which is the cost price of the asset less any accumulated depreciation.

This also helps to represent the “fall” in value of the asset over time due to wear and tear and age etc.

The journal entry should be as follows:

• Dr Depreciation Expense  £83.33
• Cr Accumulated Depreciation £83.33

This is now one monthly depreciation journal complete. We have put the expense through the profit and loss account and also reduced the net book value of the asset on the balance sheet.

After 10 years the asset would be fully depreciated and would no longer be shown on the company’s balance sheet as the net book value of the deliver van would be £0. However, the company can still continue to hold and use the asset as the useful life is only an estimate rather than a definitive period.

For more guidance around accounting entries please see our useful guide to basic bookkeeping here: Debits and Credits: The Very Basics. We also have a comprehensive guide to the journal entries required for IFRS 16 accounting, which is going to be a big change in the way fixed assets are accounted for here: What are the Journal Entries for IFRS 16?