Definition of Depreciation
Depreciation is the systematic allocation of an asset's cost to expense over the useful life of the asset.
Example of Depreciation
Let's assume that a retailer purchased displays for its store at a cost of $120,000. The displays have a useful life of 10 years and will have no salvage value. The straight-line method of depreciation will result in depreciation of $1,000 per month ($120,000 divided by 120 months). The monthly journal entry to record the depreciation will be a debit of $1,000 to the income statement account Depreciation Expense and a credit of $1,000 to the balance sheet contra asset account Accumulated Depreciation.
Depreciation on the Income Statement
The depreciation reported on the income statement is the amount of depreciation expense that is appropriate for the period of time indicated in the heading of the income statement.
Using our example, the monthly income statements will report $1,000 of depreciation expense. The quarterly income statements will report $3,000 of depreciation expense, and the annual income statements will report $12,000 of depreciation expense. Each month $1,000 of depreciation expense is being matched to the 120 monthly income statements during which the displays are used to generate sales revenues.
Depreciation on the Balance Sheet
The depreciation reported on the balance sheet is the accumulated or the cumulative total amount of depreciation that has been reported as depreciation expense on the income statement from the time the assets were acquired until the date of the balance sheet.
Using our example, after one month of use the accumulated depreciation for the displays will be $1,000. After 24 months of use, the accumulated depreciation reported on the balance sheet will be $24,000. After 120 months, the accumulated depreciation reported on the balance sheet will be $120,000. At that point, the depreciation will stop since the displays' cost of $120,000 has been fully depreciated. If the displays continue to be used in the 11th year, there will be no depreciation expense in the 11th year and the accumulated depreciation will continue to be $120,000.