Selecting a method for calculating and recording depreciation will determine what is reflected in the accounting ledger. In fact, an accountant may keep one record using a particular method for tax purposes and another record using a different depreciation method for the company’s purposes. This is a legal practice.
The Generally Accepted Accounting Principles (GAAP) has different requirements than the tax laws when it comes to recording depreciation. This is because the two entities have different objectives. The company’s purpose for financial reporting is to measure it’s economic activity by matching revenues and expenses for a given period of time. The government’s purpose for tax laws is to collect revenue and to stimulate the economy.
Therefore, often accountants will choose the accelerated depreciation method for tax purposes because they offer the greatest tax deductions. But when it comes to using a depreciation method for company purposes, they may choose the straight-line depreciation method.
Steps for Recording Depreciation Expense
- Estimate the useful life of the asset: This amount is typically determined when the asset is new. It is measured in years or units of output.
- Estimate the salvage value: This is an estimation of the amount the company anticipates receiving at the end of the asset’s useful life.
- Compare the depreciation expense: Choose from the methods below. it is important to select a method and use it consistently throughout accounting practices. Typically, except when using the double declining method, the salvage value is deducted from the cost of the asset to determine the depreciable base.
- Enter the depreciation expense in the journal: Credit a contra-asset account called Accumulated Depreciation. This account reflects how much depreciation has been accumulated over the asset’s life.
- Straight-line depreciation
- Units-of-output depreciation
- Declining balance depreciation (This method can be broken down into 2 other categories).
- Double declining balance depreciation
- Sum-of-the years’-digits depreciation