Contra Accounts & Accumulated Depreciation

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  • 0:05 What Is Depreciation?
  • 0:39 Depreciation Schedules
  • 2:16 Journal Entries
  • 2:47 Balance Sheet Presentation
  • 3:08 Lesson Summary
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Lesson Transcript
Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

Let's go through an example and see how depreciation is calculated and how depreciation expense is journalized. We will also see how the contra account called accumulated depreciation reduces the value of the asset on the balance sheet.

What Is Depreciation?

Fast Freddie owns a food truck business in a major city. He makes most of his money feeding lunch to hungry office workers who like to eat outside. Once Freddie accumulated some assets for the business, his office manager Rita told him they would need to set up depreciation for those assets. Depreciation is the process of spreading the cost of assets over the time they will be in service by the business. It is also a systematic reduction in the value of the assets over time. It is an application of the matching principle, which is a central feature of GAAP accounting.

Depreciation Schedules

Rita wants to meet with Freddie to set up depreciation schedules for their truck and office equipment. In order to do that, they will need to figure out three things for these assets:

  1. They will need to determine what accountants call its useful life, which is how long the asset will last. Freddie thinks the truck will last for 75,000 miles. Rita thinks the office furniture and equipment are good for 10 years.
  2. They need to consider the salvage value of these assets. The salvage value is what the asset is expected to be worth after its useful life is over. Rita doesn't think the office equipment will be worth much after 10 years of use. Freddie agrees that they should just give it away to some new business that needs it. He also thinks the truck will be worth about $5,000 after all that use.
  3. They need to determine which depreciation method they want to use. For the office equipment they decide to use straight line, which divides the cost of the asset by the number of years they expect the asset to last. For the truck, however, they will go with units of production based on miles driven because this depreciation method allocates more of the cost to the periods when the truck is getting heavy use.

The amount they will depreciate is the asset's total cost less its salvage value. The office equipment was purchased for $10,000. The truck was purchased for $50,000 and will have a salvage value of $5,000. It was driven 15,000 miles last year. Based upon these figures, Rita then worked up the amounts for this year's depreciation on a schedule (shown below):

Asset Amount Calculation
Truck $9,000 Cost - salvage value = $50,000 - $5,000 = $45,000
Miles driven / total miles = 15,000 / 75,000 = 0.20
$45,000 * 0.20 = $9,000
Office equipment $1,000 Straight line depreciation equals $10,000 / 10 years = $1,000 per year

Journal Entries

Depreciation is an expense for the period. The accumulated depreciation account is a contra account. Contra accounts are accounts associated with an asset and are used to reduce their net value. In this case, the accumulated depreciation on an asset is all of the depreciation expense that has been taken to date on the asset. The accumulated depreciation reduces the value of the asset on the company's books.

Here is what the journal entries for Fast Freddie's depreciation expense look like:

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