Depreciation
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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๐ท๏ธ Example:
Youโve 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. Hereโs how the bill for the Macbook Air is entered into the system. Note that we use an "Asset" account.
![Depreciation](/images/user-guide/depreciation.webp)
2. Hereโs how the bill for the Fountain Pen is entered into the system. Note that we use an "Expense" account.
![Depreciation](/images/user-guide/depreciation-2.webp)
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.
![Depreciation](/images/user-guide/depreciation-3.webp)
4. Now, letโs make a journal entry for the Macbook Air's yearly depreciation of $400. There are various methods to calculate depreciation rates; itโs 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.
![Depreciation](/images/user-guide/depreciation-4.webp)
๐ 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.
![Depreciation](/images/user-guide/depreciation-5.webp)