The journal entry for depreciation contains a debit to the income statement account Depreciation Expense and a credit to the balance sheet account Accumulated Depreciation.

The purpose of the journal entry for depreciation is to achieve the matching principle. In each accounting period, part of the cost of certain assets (equipment, building, vehicle) gets moved from the balance sheet to depreciation expense on the income statement so it can be matched with the revenues obtained by using these assets.

The account Accumulated Depreciation is reported under the asset heading of Property, Plant and Equipment. It is also known as a contra asset account because it is an asset account with a credit balance. Because Accumulated Depreciation is a balance sheet (or real or permanent) account, its balance will carry over to the next accounting period. This means that its credit balance could get as large as the cost of the assets being depreciated.

The income statement account Depreciation Expense is a temporary account. At the end of each year, its balance is transferred out of the account and Depreciation Expense will begin the new year with a zero balance.

It is important to realize that when the depreciation expense entry is recorded, a company's net income is reduced by the expense, but its cash is not reduced. (Cash would have been reduced when the asset was acquired.) You should also realize that depreciation is an estimate based on the asset's historical cost (not its replacement cost), its estimated useful life, and its estimated salvage value. The focus of depreciation is to allocate and match the cost to expense and it is not to provide an estimate of the current value of the asset. As a result, the market value of a one year old computer will likely be less than the remaining amount reported on the balance sheet. On the other hand, a rental property in a growing area might have a market value that is greater than the remaining amount reported on the balance sheet.

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