Depreciation of Fixed Assets: Methods and Accounting Treatment
- Graziano Stefanelli
- Jun 16
- 3 min read
Depreciation is a core concept in financial accounting, essential for accurately reporting the value and expense of long-term tangible assets.
Our article explains the main depreciation methods, practical accounting procedures, illustrative journal entries, and relevant standards under US GAAP and IFRS.
1. What Is Depreciation?
Depreciation is the systematic allocation of the cost of a fixed (tangible) asset over its useful life. Fixed assets, such as machinery, vehicles, buildings, and equipment, lose value over time due to usage, wear and tear, and technological obsolescence. Depreciation spreads the cost of these assets as an expense on the income statement across the periods benefiting from their use.
Key Points:
Applies to tangible, long-term assets with a limited useful life.
Land is not depreciated as it typically does not lose value over time.
Depreciation affects both the income statement (expense) and balance sheet (asset value).
2. Depreciation Methods
The method chosen for depreciation should reflect how the asset’s economic benefits are consumed. Commonly used methods include:
a) Straight-Line Method
The most widely used and simplest approach. Depreciation expense is the same each year.
Formula:
(Cost − Residual Value) / Useful Life
Example:
An equipment costing $10,000 with a residual value of $1,000 and useful life of 5 years:Annual Depreciation = ($10,000 − $1,000) / 5 = $1,800
b) Declining Balance Method
An accelerated depreciation method where a fixed percentage is applied to the asset’s book value at the start of each year. Depreciation expense decreases over time.
Formula:
Book Value at Start of Year × Depreciation Rate
Double-Declining Balance (DDB): Rate is 2 × straight-line rate.
Example:
Straight-line rate: 20% (for 5-year life). DDB rate = 40%.Year 1 Depreciation = $10,000 × 40% = $4,000
c) Units-of-Production Method
Depreciation is based on actual usage or production output.
Formula:
(Cost − Residual Value) / Estimated Total Units Produced × Actual Units This Period
Example:
Equipment expected to produce 50,000 units; actual for the year: 8,000 units.Per Unit Depreciation = ($10,000 − $1,000) / 50,000 = $0.18Annual Depreciation = 8,000 × $0.18 = $1,440
d) Sum-of-the-Years’-Digits Method
Another accelerated method. The depreciable base is multiplied by a fraction that decreases each year.
Fraction:
Remaining Useful Life / Sum of the Years’ Digits
For a 5-year life, sum = 5+4+3+2+1 = 15.
Example (Year 1):
Fraction = 5/15; Year 1 Depreciation = ($10,000 − $1,000) × 5/15 = $3,000
3. Accounting Treatment and Journal Entries
a) Initial Recognition
When a fixed asset is purchased:
Debit: Fixed Asset (e.g., Machinery)
Credit: Cash or Accounts Payable
Example:
To record purchase of machinery for $10,000:
Dr. Machinery $10,000
Cr. Cash $10,000
b) Annual Depreciation Expense
At the end of each accounting period, record depreciation:
Debit: Depreciation Expense (Income Statement)
Credit: Accumulated Depreciation (Contra-asset, Balance Sheet)
Example (Straight-Line, $1,800 per year):
Dr. Depreciation Expense $1,800
Cr. Accumulated Depreciation $1,800
c) Disposal of Assets
When the asset is sold or disposed, remove both the asset and accumulated depreciation from the books, and recognize any gain or loss.
Example:
Asset cost: $10,000; Accumulated Depreciation: $7,200; Sale proceeds: $3,000
Dr. Accumulated Depreciation $7,200
Dr. Cash $3,000
Cr. Machinery $10,000
Dr./Cr. Loss or Gain on Disposal (plug for balance)
4. Financial Statement Presentation
Balance Sheet: Fixed assets shown at cost, less accumulated depreciation.
Income Statement: Depreciation expense reported within operating expenses.
Cash Flow Statement: Depreciation added back to net income under the indirect method (as it is a non-cash expense).
5. Standards Reference (US GAAP & IFRS)
US GAAP: ASC 360 “Property, Plant, and Equipment”
IFRS: IAS 16 “Property, Plant and Equipment”
Both standards require:
Allocation of asset cost over useful life.
Review and update of useful life, residual value, and depreciation method at least annually.
Disclosure of depreciation methods and rates in the notes.
6. Practical Considerations
Choice of method: Should reflect asset usage pattern.
Tax impact: Accelerated methods may reduce taxable income earlier.
Asset componentization: Under IFRS, significant components of assets with different useful lives should be depreciated separately.
7. Example Table: Depreciation Methods Compared
8. Common Errors and Best Practices
Forgetting to update useful life or residual value: Regular review is required.
Failing to depreciate asset components separately (IFRS): Can lead to misstatement.
Not recognizing impairment: Assets must not be carried above recoverable amount.
Omitting disclosures: Accounting policy, useful lives, and depreciation rates must be disclosed.
9. References
ASC 360 (US GAAP)
IAS 16 (IFRS)
Company financial statement notes
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