Cost of purchasing the a fixed Asset like a machine or vehicle is not the only cost attached to the product. Most of the Fixed Assets that you use for your Business manifest wear and tear during the period primarily because of wear and tear or being a part of former technology. This reduces the monetary value of that Asset which in Accounting term is referred to as Depreciation.
Secondary, when you run a Business, you would always have to upgrade or replace assets with respect to requirements of your Business or Assets being outworn. Hence, a widely used practice in Accounting is to create a liability in advance and segregate an amount particularly for that accrued Expense.
For Example, if you purchase a laptop for your Business for value X, at the end of every financial year you should charge depreciation to that laptop with some percentage that reflects in books of accounts that the value of this particular asset has been reduced due to being outworn or outdated.
There are several ways by which you can charge Depreciation:
The straight-line depreciation method is the most widely used and is also the easiest to calculate. The method takes an equal depreciation expense each year over the useful life of the asset.
Periodic Depreciation Expense = (Fair Value – Residual Value) / Useful life of Asset
For example, Company A purchases a building for Rs 50,000,000, to be used over 25 years, with no residual value. The annual depreciation expense is Rs 2,000,000, which is found by dividing Rs 50,000,000 by 25.
A declining balance depreciation is used when the asset depreciates faster in earlier years. As the name implies, the depreciation expense declines over time. To do so, the accountant picks a factor higher than one; the factor can be 1.5, 2, or more.
A 2x factor declining balance is known as a double-declining balance depreciation schedule. As it is a popular option with accelerated depreciation schedules, it is often referred to as the “double declining balance” method.
How to Charge Depreciation In Book Keeper?
Please consider below example for recording depreciation entry:
A company bought machinery for Rs. 10000 and depreciation rate is 10%.
a) Depreciation on fixed assets is the loss of business, and every loss will be debited. Create an account for 'Depreciation' under 'Indirect Expenses'
b) There is a decrease in asset and we will apply what goes from business on it. So, Machinery (Fixed Asset) account will be credited.
Create Journal transaction as follows:
Depreciation A/c Debit 1000
Machinery A/c Credit 1000
The value of depreciation will be calculated manually as per the method followed in your Book of Accounts previously or the on that you wish to chose, as the same method needs to followed for each year for depreciation.