Depreciation on the Balance Sheet: Where Does It Go and Why It Matters

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What is fixed asset depreciation?

Fixed asset depreciation is a fundamental accounting principle that enables companies to distribute the expense of long-term tangible assets throughout their useful effective lives.

Assets like machinery, buildings, vehicles, and equipment used in business functions experience a decline in value over time due to factors such as wear and tear, obsolescence, or aging.

Depreciation captures this incremental reduction in value, offering a structured method for recognizing expenses and ensuring precise financial reporting.

Depreciation, from an accounting standpoint, allows organizations to align the expense of utilizing an asset with the income it produces. This practice is in accordance with the matching principle of accounting, which dictates that expenses must be recognized in the same timeframe as the revenues they contribute to generating.

By allocating the cost of an asset over its useful lifespan, businesses prevent the misrepresentation of financial statements that would result from expensing the full cost in one period.

Tax: Depreciation is recognized as a tax-deductible expense in numerous jurisdictions, leading to a decrease in a company’s taxable income. Governments typically outline the permissible methods and rates for depreciation, which businesses are required to follow to maintain accurate tax reporting.

Books: Implementing depreciation on balance sheet is important for effective financial management on a global scale. It influences decisions related to the acquisition, upkeep, and replacement of assets. Proper depreciation methods not only improve transparency but also offer stakeholders a clear perspective on the financial well-being of a company’s balance sheet. By effectively managing depreciation, businesses can align asset costs with operational performance and maintain compliance with accounting standards, e.g. IFRS and US GAAP.

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Depreciation on balance sheet

Fixed asset depreciation is a non-cash accounting expense and does not appear as a distinct line item on the balance sheet. Rather, its effects are seen in the valuation of fixed assets. The accounting for depreciation involves two interconnected entries: gross fixed assets and accumulated depreciation, which collectively establish the net book value of an asset.

Gross Fixed Assets represent the original purchase cost of tangible assets such as buildings, machinery, and equipment. This value remains unchanged on the balance sheet over time, irrespective of the asset’s usage or age.

Accumulated Depreciation is a contra-asset account that offsets the gross fixed assets. It represents the total depreciation expense charged against the asset since its acquisition. This account grows annually as depreciation is recorded, reducing the asset’s book value over time.

The equation commonly used to reflect the relationship is:

Net Book Value = Gross Fixed Assets – Accumulated Depreciation

The Net Book Value of fixed assets is presented on the balance sheet within the Property, Plant, and Equipment (PP&E) section or a comparable category. This figure offers stakeholders an assessment of the assets’ remaining economic value at a specific point in time.

Best accounting practice ensures depreciation on balance sheet calculations comply with relevant accounting standards, including International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (US GAAP). Accurate fixed asset recording and depreciation combined with routinely assessing the useful lives and residual values of assets, helps to maintain reliable financial reporting.

Where does depreciation go on the income statement (profit and loss report)

Under best accounting practices, depreciation expense is typically transferred from the balance sheet and periodically included in the operating expenses section of the income statement (also known as the profit and loss statement).

AssetAccountant is fixed asset accounting software that specializes in achieving this for subscribers with only a few fixed assets, or for those organizations with many hundreds of thousands of assets in their reconciliation.

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Depending on the nature of the business and the presentation format, it may appear as a separate line item labeled “Depreciation Expense” or be incorporated into broader categories such as “Selling, General, and Administrative Expenses (SG&A)” or “Cost of Goods Sold (COGS).”

For manufacturing entities, a portion of depreciation related to production equipment may be included in COGS, directly tied to goods produced and sold.

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We monitor changes to tax rulings and accounting standards like IFRS and US GAAP so you don’t have to.

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