Creating Provisions for Depreciation

Assets that are used by a company for more than an accounting year are referred to as “fixed assets”. Once used, fixed assets lose some of their value. When it comes to fixed assets, “Depreciation” refers to a decrease in their value as a result of wear and tear or obsolescence. In other words, the value of a machine decreases with time when it is put to use in a production process by a company. Even if the equipment is not utilised in the production process, we cannot expect it to be sold at the same price owing to the passage of time or the release of a newer model (obsolescence). In this context, depreciation is used to refer to the reduction in the value of fixed assets.

What is Depreciation?

Permanent, continuous, and gradual depreciation of fixed assets can be characterised as depreciation. It is based on the cost of the assets that a corporation uses rather than its market value.

Depreciation has a substantial impact on a company’s financial situation and operating outcomes, which are measured and presented in a variety of ways. For each accounting period, the extent of the depreciable amount is taken into consideration.

The ‘expected useful life of an asset is another consideration in allocating depreciable amounts. One way to think about it is that it’s “either how long an asset will be used by the company, or (ii) how much production of units will be gained from the company’s usage of the asset.”

Creating Provisions for Depreciation

An asset’s depreciation provision or accrued depreciation can be tracked using this method, which is commonly referred to as “Provision for Depreciation”. When depreciation accumulates over the course of a product’s useful life, the asset’s cost is never changed; therefore, the asset account is always shown at its original cost. This method of calculating depreciation has a few key characteristics.

Provisions for Depreciation Journal Entry

As long as the asset is in use, its cost is recorded in the asset account rather than being deducted from the asset’s value at the end of an accounting year.

This approach is used to record the following diary entries:

1.  The asset is purchased 

    Asset A/C                   …dr              (Cost of Machinery/Equipment/etc.) 

       To   Bank A/C or Vendor’s A/C     (Depending on the method of payment – cash or credit) 

2. At the end of each year, you have to make two journal entries to create a provision for depreciation: 
3.   Depreciation A/C        …dr         (With the depreciation amount)

            To    Provision for Depreciation A/C 

 4. Next, you have to make adjustments for the provision so that it reflects on the Profit & Loss A/C: 

      P/L A/C           …dr   (With the depreciation amount) 

           To Depreciation A/C   

Treatment of the financial statements:

It appears on the balance sheet as a fixed asset at its original cost. On the “liabilities side” of the balance sheet, or by deducting the asset’s original cost from the asset’s current value, the depreciation accrued up to that date is reflected as a deduction from its value.

Conclusion

For a company’s balance sheet, a depreciation provision is a way to more precisely reflect how much money it has invested in fixed assets. You can look at different provisions for depreciation to understand the concept better. We hope that this provision for depreciation article helps you understand how to pass journal entries.