Asset Depreciation Process

Tip

This section is intended for those who work with Fixed Assets but do not have a background in accounting and may not be familiar with the concept of depreciation.

Fixed, or plant, assets are resources used to operate your institution and are owned for more than one year. Examples of fixed assets typically include vehicles, computers, machinery, equipment, land, and buildings. All fixed assets, with the exception of land, depreciate in value because of actual use or obsolescence.

Depreciation is used to show the decline in usefulness of the asset rather than a decrease in its book value; therefore, the depreciation process includes:

Creating a depreciation schedule
Creating and recording depreciation (expense) transactions
Maintaining the history of a depreciating asset

Your institution purchased an automobile for $20,000. The car is expected to last for five years, so one-fifth of its value can be expensed each year to the department or area of operation that uses the vehicle. Thus, that area or department would be "charged" $4,000 each year for five years.

Note

This is a simple example. A real calculation may include an additional expense in the first period to account for the loss of value at purchase as well as consideration for the amount the vehicle may sell for when it is disposed.

The depreciation expense account and the accumulated depreciation account typically contain all of the assets of a particular type; however, assume that we have an asset account and an accumulated depreciation account for only one asset.

Using the example above, when the automobile was purchased, the asset account balance would be $20,000 and the accumulated depreciation account balance would be $0. As depreciation expense is recorded, the accumulated depreciation expense will increase.

The accumulated depreciation account is an offset to the asset account; thus, when we net the two accounts, the result is the book value of the asset. In this example, after one year with the amount of depreciation being $4,000 per year, the asset account balance would still be $20,000 but the accumulated depreciation account balance would be $4,000. The original cost ($20,000) is offset by the total depreciated value to date ($4,000), resulting in a book value of $16,000 ($20,000 - $4,000 = $16,000).

The following table shows the asset account and accumulated depreciation account balances over the life of the asset.

Date of Purchase	Asset Account	Accumulated Deprecation Account	Book Value of Asset
	$20,000	0	$20,000
Year 1	$20,000	$4,000	$16,000
Year 2	$20,000	$8,000	$12,000
Year 3	$20,000	$12,000	$8,000
Year 4	$20,000	$18,000	$4,000
Year 5	$20,000	$20,000	0

Depreciation Account Types

The following ledger accounts are commonly used in the depreciation process:

Fixed Asset Account: This account contains the original cost of all of the assets of that particular type. There will normally be multiple asset accounts for this purpose, each one containing assets of different categories and in different funds. Some examples of account titles are Current Tangible Assets, Plant and Equipment, or Operational Assets. This type of account normally carries a debit balance.

Accumulated Depreciation:This account offsets the amount of a fixed asset account. The difference between the fixed asset account and the accumulated depreciation account is the book value of the assets. Although accumulated depreciation carries a credit balance, it is recorded in the Assets section of the Balance Sheet to show it is a Fixed Asset contra account.

Depreciation Expense:This account records the expense charged each period for the use of an asset. You may find that depreciation expense accounts are used at the department level, but depreciation expense is more commonly tracked as a net amount for an area of operation or an entire fund. An expense account normally carries a debit balance.

Gain/Loss on Sale of Assets: This account is used to record the net gain or loss when an asset is sold or traded. This account may carry a debit or credit balance depending on whether there were more net gains or losses for the year.

Depreciation Methods

The factors used to calculate depreciation in these methods include actual cost of the asset, its useful life (in years), and its residual value. Different depreciation methods produce different results. Some assets usefulness declines early, resulting in high maintenance costs as they age.

Jenzabar delivers two methods for calculating depreciation of fixed assets.

Declining-Balance: This method is an accelerated depreciation method that uses a constant percentage rate applied to the previous year's value rather than to the original cost.
Straight-Line: This method uses an equal amount of depreciation expense assigned to each year (or period) of asset use. Depreciable cost is divided by useful life in years to determine the annual depreciation expense.

Using an accelerated depreciation method (e.g., Declining-Balance) allows for faster write-offs during the early life of the asset, which helps balance costs over the assets lifespan.

When capital purchases are made (i.e., buying a tangible asset) and assuming the asset is purchased for cash, cash will be reduced and tangible assets will be increased. As the depreciation process takes place, a depreciation expense account will be charged and accumulated depreciation will be recorded each time a portion of the asset is expensed. The accumulated depreciation account will offset the asset account, and the net of the two accounts will show the book value of the asset.

Declining-Balance Depreciation Method Example

Assume the initial price of Equipment is $100,000, and its residual value after 5 years is $20,000. You would use the following equation: Annual Depreciation = Previous Year's Value / Time

Year	Depreciation	Year-End Value
1	($100,000/5) = $20,000	$100,000 - $20,000 = $80,000
2	($80,000/5) = $16,000	$80,000 - $16,000 = $64,000
3	($64,000/5) = $12,800	$64,000 - $12,800 = $51,200
4	($51,200/5) = $10,240	$51,200 - $10,240 = $40,960
5	($40,960/5) = $8,192	$40,960 - $8,192 = $32,768

This method assumes more depreciation in the earlier years of an asset's life and the final value ($32,768) is more than the residual value ($20,000). Because the residual value is not part of the calculation, it and the final value may not be equal; the asset cannot be depreciated beyond the estimated residual value. However, your accountant may adapt this method to force the equality of these two values.

Straight-Line Depreciation Method Example

Assume the initial price of Equipment is $100,000 and its residual value after 5 years is $20,000. You would use the following equation: Annual Depreciation = (Initial Price Residual Value) / Time

Year	Depreciation	Year-End Value
1	($100,000-$20,000/5) = $16,000	$100,000 - $16,000 = $84,000
2	($100,000-$20,000/5) = $16,000	$84,000 - $16,000 = $68,000
3	($100,000-$20,000/5) = $16,000	$68,000 - $16,000 = $52,000
4	($100,000-$20,000/5) = $16,000	$52,000 - $16,000 = $36,000
5	($100,000-$20,000/5) = $16,000	$36,000 - $16,000 = $20,000

Since the residual value is part of the calculation, the residual value and the final value are the same.