Explanation

After calculating depreciation using a suitable approach, it must be brought to books.

The accounting entries for depreciation are generally made at the end of each financial year. A new account called the depreciation account, or more appropriately the depreciation expense account, is opened in the books.

This account is debited by the amount of depreciation to be provided for the year. Alongside this, the fixed asset account concerned is credited by the same amount.

The effect of this entry is that the depreciation expense account shows the amount of expense for the year, while the fixed asset account shows a reduced balance.

The depreciation expense account, being a nominal account, is closed at the end of each financial year by transferring its balance to the profit and loss account.

Example

ABC company purchased a motor vehicle for $75,000 on 1 January 2016. The company plans to provide depreciation at 20% per year using the reducing installment method.

Required: Show the following accounts in the company’s ledger for 2016, 2017, and 2018:

  1. Motor vehicle account
  2. Depreciation account
  3. The relevant portion of the profit and loss account

Solution

Step 1: Calculation of depreciation for 2016, 2017, and 2018

For 2016:

  • Book value (original cost for the first year) at the beginning of 2016: $75,000
  • Depreciation for 2016: $75,000 × 0.2 = $15,000

For 2017:

  • Book value at the beginning of 2017: $75,000 – $15,000 = $50,000
  • Depreciation for 2017: $50,000 × 0.2 = $10,000

For 2018:

  • Book value at the beginning of 2018: $50,000 – $10,000 = $40,000
  • Depreciation for 2018: $40,000 × 0.2 = $8,000

Step 2: Prepare the ledger accounts

Motor Vehicle Account
Depreciation Expense Account

At the end of all three years, depreciation will appear on the debit side of the profit of loss account as an expense. It is shown below:

Accounting Treatment of Depreciation

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