How to Record a Depreciation Journal Entry

Managing depreciation can feel overwhelming for inexperienced accountants and bookkeepers. But in reality, once you’re familiar with depreciation and the different depreciation methods you can use, the process becomes much simpler.

Overview: What is the journal entry for depreciation?

Depreciation can be one of the more confusing aspects of accounting. The purpose of depreciation is to allocate the cost of a fixed or tangible asset over its useful life.

Using depreciation allows you to avoid incurring a large expense in a single accounting period, which can severely impact both your balance sheet and your income statement.

Once depreciation has been calculated, you’ll need to record the expense as a journal entry. The journal entry is used to record depreciation expenses for a particular accounting period and can be recorded manually into a ledger or in your accounting software application.

In order to create a journal entry for depreciation, you first need to become familiar with the following accounting terms:

• Cost: The cost of the asset you’ll be depreciating is of particular importance. The cost serves as the basis for your depreciation calculation and should include all related expenses such as shipping, taxes, or any additional warranty.
• Useful life: Once you have your cost basis, you’ll need to estimate the useful life of the asset. If you purchase a copier that you expect to last for five years, you’ll base your calculations and your journal entry on the cost and the useful life.
• Salvage value: It may seem a little odd to be thinking about salvage value for a new asset, but you’ll have to determine this before creating a journal entry. That’s because salvage value plays a role in how depreciation is calculated, depending on the method you choose.

What are the 4 types of journal entries for depreciation?

While your journal entry process will remain the same for each type of depreciation, your journal entry totals will change based on the depreciation method you choose. There are numerous depreciation methods that you can use, but most businesses use one of these four methods:

1. Straight line depreciation

Straight line depreciation is the easiest depreciation method to use. It keeps your depreciation expense the same for each year in the life of an asset.

2. Double declining depreciation

Double declining depreciation is best for an asset that depreciates quickly in its early years, such as an automobile.

Double declining depreciation calculates depreciation at twice the rate as straight-line and uses book value, which is the value of the asset according to your general ledger (rather than the original cost of the asset), to calculate depreciation for subsequent years.

3. Sum-of-the-years depreciation

Sum-of-the-years depreciation is based on the total number of years an asset is expected to last. For example, if you determine that the useful life of an asset is three years, you would calculate depreciation by adding those years together:

1 + 2 + 3 = 6

Like double declining, sum-of-the-years is best used with assets that lose more of their value early in their useful life.

4. Units of production depreciation

The units of production depreciation method is useful when calculating depreciation for a piece of equipment or machinery whose useful life is based on the number of units it will produce rather than a specific number of years.

Remember that depreciation rules are governed by the IRS, and the method you choose to depreciate your assets will directly affect year-end taxes, so choose wisely. The method currently used by the IRS is the Modified Accelerated Cost Recovery System (MACRS).

This method requires you to assign each depreciated asset to a specific asset category. An updated table is available in Publication 946, How to Depreciate Property. When using MACRS, you can use either straight-line or double-declining method of depreciation.

How to calculate the depreciation expense journal entry

Calculating depreciation will differ depending on the method of depreciation you’ve chosen.

Straight line method

Straight-line depreciation is the simplest depreciation calculation. All you need to do is determine the cost of the asset, its salvage value, and its useful life. For example, if you purchase a piece of machinery for $3,900, determine its salvage value to be $1,000, and its useful life to be three years, your depreciation formula would be:

($3,900 - $1,000) ÷ 3 = $966.67

This yields your annual depreciation figure. If you’re recording depreciation monthly, you’ll do a second calculation:

$966.67 ÷ 12 = $80.56

With this method, your monthly depreciation amount will remain the same throughout the life of the asset.

Double declining balance method

Double declining depreciation is a good method to use when you expect the asset to lose its value earlier rather than later. Compared with the straight-line method, it doubles the amount of depreciation expense you can take in the first year.

Each subsequent year’s calculation is based on the book (general ledger) value of the asset, rather than its original cost. To calculate double declining depreciation for the same asset we used above, you would do the following:

($3,900 ÷ 3) x 2 = $2,600

This yields your depreciation expense for the asset’s first year of use. Your monthly depreciation expense would be one-twelfth of this figure:

$2,600 ÷ 12 = $216.67

This will change each year, as you would use the new book value, which would be $1,300 (the original price of the asset minus the amount already depreciated), to calculate the following year’s depreciation.

Sum-of-the-years method

More complicated than the first two depreciation methods, sum-of-the-years depreciation adds the sum of the useful life of the asset. Using the example from above, an asset with a useful life of three years would be calculated as follows:

1 + 2 + 3 = 6

The first year depreciation calculation would be:

(3 ÷ 6) x $3,900 = $1,950

To calculate depreciation by month:

$1,950 ÷ 12 = $162.50

Your sum-of-the years depreciation calculation and expense will change each year, with each subsequent year using the declining number. For example, the calculation for the second year would be:

(2 ÷ 6) x $3,900 = $1,300

Units of production method

This method is used only when calculating depreciation for equipment or machinery, the useful life of which is based on production capacity rather than a number of years.

For example, a recently purchased copier is estimated to handle 250,000 copies during its useful life. Units of production depreciation does use salvage value, so your first year calculation would look like this:

($3,900 - $1,000) ÷ 250,000 = $0.015

This means that for every copy produced, you’ll multiple that number times $0.015. For example, if you make 35,000 copies the first year, you’ll calculate depreciation as follows:

$0.015 x 35,000 = $525

Units of production depreciation will change monthly, since it’s based on machine or equipment usage.

Remember that depreciation rules are governed by the IRS, and the method you choose to depreciate your assets will directly affect year-end taxes, so choose wisely. The method currently used by the IRS is the Modified Accelerated Cost Recovery System (MACRS).

This method requires you to assign all depreciated assets to a specific asset category. An updated table is available in Publication 946, How to Depreciate Property. When using MACRS, you can use either straight-line or double-declining method of depreciation.

How to record the depreciation journal entry

The journal entry for depreciation is considered an adjusting entry, which are the entries you’ll make prior to running an adjusted trial balance.

Prior to recording a journal entry, be sure that you have created a contra asset account for your accumulated depreciation, which will be used to track your accumulated depreciation expense entries to date. When recording a journal entry, you have two options, depending on your current accounting method.

1. Recording the entry manually

Even if you’re using accounting software, if it doesn’t have a fixed assets module, you’ll still be entering the depreciation journal entry manually. For those still using ledgers and spreadsheets, you’ll also be recording the entry manually, but in your ledgers, not in your software.

To record depreciation using the straight-line example above, you need to make the following journal entries:

2. Using accounting software

If you’re lucky enough to use an accounting software application that includes a fixed assets module, you can record any depreciation journal entries directly in the software. In many cases, even using software, you’ll still have to enter a journal entry manually into your application in order to record depreciation expense.

Calculating and recording depreciation is important

It may not be your favorite task in the world, but calculating and recording depreciation expenses should not be overlooked.

Calculating depreciation accurately and recording it promptly can help reduce your taxes, provide investors with a much better picture of your business finances, and ensure that your balance sheet and income statement are accurate.