This guide dives into the concept of depreciation, a fundamental accounting principle that allocates the cost of an asset over its useful life. Let's explore how it works through a practical example!

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Finance โžก๏ธ Accounting โžก๏ธ Journals โžก๏ธ Add Journal

๐Ÿท๏ธ Example:

Youโ€™ve just bought two items for your business.

  • Macbook Air: $2,000 purchase price ex GST
  • Fountain Pen: $70 purchase price ex GST

Understanding the Difference:

The key difference lies in how we treat these purchases in the financial statements.

  • Fountain Pen: With a cost below $300, the entire $70 is expensed in the current year's "Profit and Loss" statement.
  • Macbook Air: As a more expensive asset, the $2,000 cost isn't considered an immediate expense. Instead, depreciation spreads the cost over its lifespan (say, 5 years).

Let's examine how these two purchases will be recorded in the accounting system:

1. Hereโ€™s how the bill for the Macbook Air is entered into the system. Note that we use an "Asset" account.


2. Hereโ€™s how the bill for the Fountain Pen is entered into the system. Note that we use an "Expense" account.


3. When you look at both the "Balance Sheet" and the "Profit and Loss" statements, you'll find out where those two amounts go. The $70 is an instant expense, while the $2000 is recorded on the "Balance Sheet." After that, we'll use a journal to transfer the depreciated value of the Macbook Air to the "Profit and Loss" statement. Understanding this basic concept is crucial.


4. Now, letโ€™s make a journal entry for the Macbook Air's yearly depreciation of $400. There are various methods to calculate depreciation rates; itโ€™s advisable to refer to relevant guidelines. We'll specify the accounts for both credit and debit. You can leave the tax information empty.

Note: If you start using the Macbook Air halfway through the financial year, you'll need to journal only a portion of the $400 to account for the days used.


๐Ÿ Results

Take another look at both the "Balance Sheet" and "Profit and Loss" statements. You'll see that the $400 has become depreciation expenses, making the total expenses for the year $470. Keep doing this every year until the asset's value reaches $0.00.


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