When a fixed asset is depreciated, two things must be accounted for,
- The charge for depreciation is a cost or expense of the accounting period. Depreciation is an expense in the profit and loss account.
- At a same time the fixed asset is wearing out and diminishing in value. So the value of the fixed asset in the balance sheet must be reduced by the amount of depreciation charged. The balance sheet value of the fixed asset will be its net book value which is the value after depreciation in the books of account of the business.
The amount of depreciation will build up or accumulate over time, as more depreciation is charged in each successive accounting period. This accumulated depreciation is a provision because it provides for the fall in value in use of the fixed asset. The term provision for depreciation means the accumulated depreciation of a fixed asset.
The Depreciable Amount
The total amount to be charged over the life of a fixed asset or depreciable amount is usually its cost less any expected residual sales value or disposal value at the end of the asset’s life.
A fixed asset costing 50000$ which has expected life of five years and an expected residual value of 5000$, should be depreciated by 45000$ in total over the five year period.
A fixed asset costing 50000$ which has expected life of five years and an expected residual value of nil, should be depreciated by 50000$ in total over the five year period.