Accounting 203: Basic Depreciation

If you understand double entry and accruals then the next principle to understand is depreciation, appreciation, and capitalization. They are actually all the same thing and very similar to accruals. Remember when we talked about accruals we said it didn’t make any sense to only count an expense as happening when it was paid. I pay for earthquake insurance once a year, but I enjoy the benefits all year. If I only counted the expense when I paid it then I would have a very unprofitable day when I paid it and the rest of the year would look better than it really is. The point of accounting is to be able to understand a business. Counting a once a year expense only when it was paid would be misleading and not helpful for understanding the business.

Depreciation is sort of the same thing. When I buy a computer it can be a big unusual expense, but I get to enjoy its use for several years. Well enjoy might be an exaggeration and several years might not be totally true. The point is that I have to account for its expense as I use it. If I buy a computer for $100 and I use it for 100 days, then the expense is $1 per day. That makes sense. Well it is more of an estimate than you probably imagine. I know how much I will pay for an item, but how long it will be useful and what its value is when I am done are good estimates, but still estimates. Doesn’t everything we buy get used over time and therefore depreciated. No. There is a basic principle of accounting called materiality. I may buy a stapler for $1 and use it for 10 years, but the cost of the stapler is not material. In that case I would just expense it the day I bought it. Where is the material line? There isn’t one. It is a judgement call. Again the goal of accounting it to provide the best information about a business. And then there are taxes…

Tax accounting and GAAP accounting are not the same. They are similar, but definitely different. For example there is the section 179 deduction in taxes. I won’t dive into the details but essentially you can elect to count the expense in a single year rather than depreciating it over several years. If you do this then taxable income and GAAP income can vary dramatically. And then there are all the odd rules like you can’t take a section 179 deduction on air conditioning. Why? There has to be a reason, but I don’t know what it is. I am going to stay away from section 179 deductions for now.

I am going to buy 3 computers for a total of $1500 and show how I would depreciate them over time.


Here you can see a new account called office equipment. It is not a current asset. A current asset is supposed to be an asset that would be used in a year, most often cash or its equivalents. You can see the entry I made increasing the asset by $1500 and increasing my credit card balance by the same amount. (Remember double entry and increasing a liability is a credit). Now let’s see those critical statements.


You see here that even though I spent $1500 It does not affect my profit and loss. You can see the Asset in the balance sheet.

For this example I am going to depreciate the computers $300 a year for 5 years. It is perfectly acceptable to re-evaluate the value of assets. Let say that after 4 years I look at the computers and decide they are worth nothing. I could go back and restate the depreciation expense, but most likely I am going to take a $600 depreciation expense that year. Or let’s say that after 4 years I realize that I am going to keep the computers for an extra year. Well after depreciating it for 4 years the asset value is only $300. My depreciation expense is going to be $150 for those last 2 years. What do you do if you depreciate an asset like let’s say carpeting over 2 years and then after 2 years you decide to not replace the carpeting. Well since you have already expensed the value to zero it makes sense to stop depreciating.

There are few different ways to depreciate assets. They are all supposed to match the use of the asset with it’s depreciation or expense. Double declining depreciation is one such method. Then there are taxes…

Here is the entry where the asset is depreciated.


I created a new expense account called depreciation. I could have separate accounts for each depreciating account or contra asset accounts. If that is helpful for understanding the value of depreciating assets, then by all means. There could be better asset tracking methods. Quickbooks has some asset tracking features. The simplest is to not track the details of each asset in the accounting software. income

When we see how this new expense is reflected in the statements we can see that there is an additional $300 expense that lowers Net Income and the asset in the balance statement is now $1200.

How much time and effort should be placed on depreciation? That is a judgment call. Certainly for taxes you want to have the information and expenses. The other day our air conditioner went out. I thought it was the landlord’s problem, but it turns out that it is my problem. So we are going to have to spend about $10k for a new air conditioner. We assume that the air conditioner is going to last longer than me. I don’t want it to be a single expense because I am going to use it forever. I should have been depreciating the air conditioner that we inherited with the store. I did not. So I am going to take a $1000 expense every year for the air conditioner. That will lower my profitability, and my tax burden but it does nothing for my cash flow. That is a completely different accounting problem.

I haven’t mention appreciation or depletion. They are essentially the same thing. Appreciation is increasing revenue and depletion is the decreasing value of an asset that really does get used, like a copper mine. The goal of all of these methods is to match the expenses and revenues and use of assets with the actual use of those items and to not have them match to the actual cash flow.

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