key term - Depreciation Expense

Definition

Depreciation expense is an accounting concept that represents the systematic allocation of the cost of a tangible asset over its useful life. It is an expense recognized on the income statement that reflects the gradual consumption or obsolescence of a long-term asset, such as equipment, machinery, or buildings, used in the operations of a business.

5 Must Know Facts For Your Next Test

1. Depreciation expense is a non-cash expense that reduces the book value of a long-term asset over its useful life.
2. The purpose of depreciation is to match the cost of a long-term asset with the revenues it helps generate over multiple accounting periods.
3. Depreciation expense is recorded as a debit to the Depreciation Expense account and a credit to the Accumulated Depreciation account on the balance sheet.
4. The amount of depreciation expense recognized each period is determined by the depreciation method chosen, such as straight-line, declining balance, or units of production.
5. Depreciation expense affects the calculation of net income on the income statement and the valuation of long-term assets on the balance sheet.

Review Questions

• Explain how depreciation expense relates to the concept of current and noncurrent assets, and how it is recorded in the accounting records.
  • Depreciation expense is directly related to noncurrent assets, which are long-term assets that provide economic benefits to the business over multiple accounting periods. When a business acquires a noncurrent asset, such as equipment or a building, the cost of that asset is capitalized on the balance sheet. Over time, as the asset is used in the business operations, the cost of the asset is systematically allocated to the income statement as depreciation expense. This process of recording depreciation expense reduces the book value of the noncurrent asset on the balance sheet, while also reducing the net income reported on the income statement. The recording of depreciation expense involves a debit to the Depreciation Expense account and a credit to the Accumulated Depreciation account, which is a contra-asset account that offsets the original cost of the noncurrent asset.
• Describe how depreciation expense is considered in the preparation of an adjusted trial balance and the statement of cash flows using the indirect method.
  • Depreciation expense is one of the common types of adjusting entries recorded at the end of an accounting period. When preparing an adjusted trial balance, the depreciation expense account will be included as an expense, which will reduce the net income reported on the income statement. Additionally, when preparing the statement of cash flows using the indirect method, the depreciation expense recognized during the period is added back to net income, as it is a non-cash expense that reduces net income but does not impact cash flows. This adjustment is necessary to reconcile the net income figure on the income statement to the net cash provided by operating activities on the statement of cash flows.
• Explain how the choice of depreciation method can impact the allocation of capitalized costs over the useful life of a long-term asset, and how this relates to the preparation of the statement of cash flows using the direct method.
  • The choice of depreciation method, such as straight-line, declining balance, or units of production, can significantly impact the timing and amount of depreciation expense recognized each period. This, in turn, affects the allocation of the capitalized cost of the long-term asset over its useful life. When preparing the statement of cash flows using the direct method, the depreciation expense recognized during the period is not directly reported as a line item. Instead, the impact of depreciation is reflected in the changes to the asset and liability accounts on the balance sheet, which are used to calculate the net cash provided by operating activities. The choice of depreciation method can, therefore, influence the presentation and analysis of cash flows, as it affects the timing and amount of cash outflows related to the acquisition and use of long-term assets.

Related terms

Capitalized Cost: The original purchase price of a long-term asset, including any costs incurred to prepare the asset for its intended use, that is recorded on the balance sheet.

Useful Life:

The estimated period of time over which a long-term asset is expected to be used and provide economic benefits to the business.

Salvage Value:

The estimated amount a business can expect to receive when a long-term asset is sold or disposed of at the end of its useful life.