Some assets will last for years, for example, equipment, machines, buildings, furnishings, computers, vehicles, and parking lots. However, they are not going to last forever. When an accounting period passes by, a part of the value of these assets is depleted. On the income statement, you will record the depleted part as Depreciation Cost. Depreciation means that you have to transfer a part of the asset’s value from your balance sheet to your income statement when preparing financial accounting (Also see Difference between Financial Accounting and Management Accounting). You have to do this every year throughout the asset’s lifespan (Also see Accounting Tasks That You Should Complete Before New Year).
You will use two accounting principles for the reporting and calculation of depreciation:
– Cost principle. This principle demands that you have to use the initial value of the asset when you report the Depreciation Expense on your income statement, as well as the asset total amount on your balance sheet. It will be inappropriate if you use the contemporary market price of the asset, or the cost needed to substitute the asset or any other value as the amounts.
– Matching principle. This principle demands you to assign the cost of the asset to Depreciation Expense throughout the lifespan of the asset. You have to separate the price of the asset into smaller portions and state some of them on every income statement throughout the asset’s life (Also see Tips on How to Sort Out Your Chaotic Finances). By allocating a part of the value of the asset to several income statements, the accountant is matching a part of the asset’s price with every time interval that the asset is in use. It will be great if you can match the cost of the asset with the revenues you gained by utilising that asset.
There are some methods of depreciation that are considered as attaining the matching principle. The method of depreciation could be categorised into two groups, which are accelerated depreciation and straight-line depreciation. Regardless of which method adopted, the bookkeeper has to post the necessary double entries (Also see Advantages of double entry accounting) into the account periodically to include the effects into the account.
People often refer the assets discussed above as depreciable assets, fixed asset, constructed assets, plant assets, as well as property, plant and equipment. Please take note that as an asset, the land will not undergo depreciation, since it is considered to last forever.
Understanding depreciation is crucial to your business as it provides a clearer picture of the finances of your company. As calculating depreciation of your asset involves accounting, you should hire an accounting firm in Johor if you find it difficult to cope with the accounting tasks to ensure that you always stay on top of your company’s finances.