Depreciation: methods, journals and the ledger

What depreciation actually is

It is the allocation of cost over the asset's useful life, applying the matching concept — not a valuation, and not a fund of cash. A fully depreciated machine still in use is worth something; a newly depreciated one may be worth more than book value. Saying “depreciation shows what the asset is worth” loses the mark.

Straight line

Charge $=\dfrac{\text{cost} - \text{residual value}}{\text{useful life}}$, the same amount every year. Suits assets that give even benefit across their life: buildings, fixtures, fittings.

Reducing balance

Charge $=$ rate $\times$ net book value at the start of the year, so it is heavy early and light later. Suits assets that lose value fastest at the start or need more repairs later: vehicles, computers. Note the residual value is not subtracted first in this method.

The two accounts

Depreciation is recorded as: Dr Depreciation expense (income statement) / Cr Provision for depreciation (a contra account). The asset account itself stays at cost forever; net book value is cost minus the accumulated provision. Keeping cost and provision separate is the whole point of the system.