Purpose of Depreciation
The purpose of depreciation is to achieve the matching principle of accounting. That is, a company is attempting to match the historical cost of a productive asset (that has a useful life of more than a year) to the revenues earned from using the asset.
Since it is difficult to precisely match a productive asset's cost to a company's revenues, the asset's cost is usually allocated to the years in which the asset is used. In other words, depreciation systematically moves the asset's cost from the balance sheet to depreciation expense on the income statement over the asset's useful life. Accountants point out that depreciation is an allocation process which does not result in reporting the asset's market value.
Example of Recording Depreciation
The accounting entry to record depreciation is:
- A debit to Depreciation Expense, and
- A credit to Accumulated Depreciation (a contra-asset account that is reported in the same section of the balance sheet as the asset that is being depreciated).