Double Entry Bookkeeping Lesson - Worked Example

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Accounting for Depreciation

This covers: Depreciation, Profit & Loss, Fixed Assets, Payments, Capital and Reserves.

bookkeeping lesson depreciation accounting

1. Understand - WHAT is Depreciation

Depreciation is the loss in value of an asset over time.

Assets are Debit Balances held on the Balance Sheet.

Depreciation is a periodic charge which reduces the asset value and charges that loss in value as a cost to the Profit and Loss account or Income Statement.

In short a Debit held on the Balance Sheet becomes a Debit in the period P&L.

So the accounting double entry is:


DEBIT (DR.)

CREDIT (CR.)

Depreciation a/c

(Profit & Loss / Income Statement)

Accumulated Depreciation a/c

(Balance Sheet)


Note that the Credit - or accumulated loss in value of the asset - on the Balance Sheet is held in an account that is seperate to the Asset Cost account.


2. Understand - WHY Depreciate?

Charging depreciation adheres to the Fundamental Accounting Principle of Matching which ensures the Accounts give a true and fair view of economic activity over  the period. Assets are used to generate revenue - depreciation is a cost of that revenue.


3. Understand - WHEN and HOW to Account for Depreciation?

The depreciation charge can be journalled in to the General Ledger in one of two ways:

1. Automatically via interface from a Fixed Asset Module or Register if appplicable,

2. Manually, from a spreadsheet holding fixed asset details

Journals will be posted as part of the financial month end accounting close process.


The worked example below shows the accounting entries for straight line depreciation of a fixed asset.

Whichever depreciation method is adopted, the accounting will be the same - only the amounts charged in individual accounting periods will vary.


4. Accounting for Depreciation: Worked Example

Scenario:

Zelda: Zombie Slayer sets up a slaying business - ZZS.

She invests £10k, transferring funds in to a new bank a/c

Zelda immediately buys a state of the art ZS400 Super Slash 'n' Slay machine for £5k.

She estimates the ZS400 will be slaying for 2 years after which it will be replaced with the planned ZS500.

Zelda expects the ZS400 to be sold for spares and be worth £1k.

She believes depreciating straight-line best reflects the use of the ZS400.


Requirements:

1.  Show the double entry accounting entries for the purchase of the ZS400 and the depreciation over the 2 years

2. Show the Balance Sheet at the end of Years 1 and 2.

Ignore tax and income from slaying.


Calculations:

Cost = £5k

Residual Value = £1k

Total Depreciation = £4k

Useful Economic Life = 2 years

Depreciation per annum = £4k / 2  = £2k


SOLUTION: 1. Double Entry Accounting Entries

accounting entries for depreciation

Remember: the Depreciation charge DOES NOT IMPACT THE COST OF THE ASSET.

Instead it is accumulated in a Depreciation account on the balance sheet which is linked to / associated with the Asset Cost a/c. The two are then presented in the Balance Sheet to give the net value - the Net Book Value - as follows....


SOLUTION: 2. Balance Sheet of ZZS

depreciation and balance sheet

Keeping Accounting Simple Stupid!

One of our missions here at the Alternative Accountant is to provide simple, practical worked examples of double entry accounting across a range of real life Accounting Scenarios.

The reality of Accounting is that however sophisticated finance systems and ERP systems purport to be, the basic, simple principles of double entry accounting must - and will - always hold true.

What's more, these systems are only as good as the integrity of the processes and controls feeding them with data. As anyone who works in accounting knows, processes ALWAYS break down at some point!

A good grounding in double entry principles and mechanics is essential to understand and resolve the resulting issues and risks efficiently and correctly.


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