Introduction to Depreciation Expense

What you will learn to do: Compute depreciation expense on plant assets

In the prior section, we recorded the large-scale purchases by Spivey Company into the GL control accounts:

Three T accounts side by side. On the left is a land chart. There is a dash representing the beginning balance on the debit side. There is a debit entry on February 1st of 262,800 dollars. There is a debit entry on October 1st of 120,000 dollars. There is a debit total of 382,800 dollars. In the middle is a machinery chart. There is a dash representing the beginning balance on the debit side. There is a debit entry on July 1st of 162,000 dollars. There is a debit entry on October 1st of 220,000 dollars. There is a debit total of 382,000 dollars. On the right is a building chart. There is a dash representing the beginning balance on the debit side. There is a debit entry on July 1st of 490,000 dollars. There is a debit entry on October 1st of 600,000 dollars. There is a debit total of 1,090,000 dollars.

In addition, we would have recorded those same transactions into a subsidiary ledger or a fixed assets detail list. For convenience, let’s assume the July 1 purchase of machinery was one large machine, and that the lump sum purchase on October 1 was further allocated to the individual assets. Since we don’t have the time or room to account for all the items, we’ll call the individual assets (1) delivery van, (2) machine, (3) office furniture, and (4) computer. In reality, you would break this list down into the smallest detail that made sense for your business; usually each individual asset would get its own line. Here is an example of a fixed asset item list:

Fixed Assets
As of 12/31/20X1
Spivey Company
Asset Description Date Purchased Cost
1 Land 2/1/20X1 262,800
2 Building 7/1/20X1 490,000
3 Machine 7/1/20X1 162,000
4 Land 10/1/20X1 120,000
5 Building 10/1/20X1 600,000
6 Delivery Van 10/1/20X1 45,000
7 Machine 10/1/20X1 99,500
8 Office Furniture 10/1/20X1 70,000
9 Computer 10/1/20X1 5,500
Total PP&E $ 1,854,800

The total of the three GL accounts above equal the total of the fixed asset item list, but we accountants would probably sort the list to better match the GL:

Fixed Assets
As of 12/31/20X1
Spivey Company
Asset Description Date Purchased Cost
1 Land 2/1/20X1 262,800
4 Land 10/1/20X1 120,000
Total Land 382,800
2 Building 7/1/20X1 490,000
5 Building 10/1/20X1 600,000
Total Buildings 1,090,000
3 Machine 7/1/20X1 162,000
6 Delivery Van 10/1/20X1 45,000
7 Machine 10/1/20X1 99,500
8 Office Furniture 10/1/20X1 70,000
9 Computer 10/1/20X1 5,500
Total Machinery and Equipment 382,000
Total PP&E $ 1,854,800

Some companies will have more categories or different ones, for instance, breaking out vehicles, office equipment, or even computers into separate GL control accounts.

All this information is gathered and tracked and used to compute depreciation, accumulated depreciation, and eventually gain or loss on the sale of an asset. So, for step one we need to decide on a method of depreciation and apply it.

To compute the amount of depreciation expense, accountants consider four major factors:

  1. Cost of the asset (covered in the prior section).
  2. Proposed method of depreciation.
  3. Estimated useful life of the asset.
  4. Estimated salvage value of the asset. Salvage value (or scrap value or residual value) is the amount of money the company expects to recover, minus disposal costs, on the date a plant asset is scrapped, sold, or traded in.

Land won’t be depreciated because in theory it has an unlimited useful life, but all the other fixed assets will depreciate.