Depreciation: Follow the Asset, Not the Cash
Depreciation can feel like a collection of unrelated rules. It is easier when you follow one asset from the day it is purchased through the end of its useful life.
The cash payment happens when the asset is purchased.
Depreciation does not represent another cash payment. It allocates the asset's depreciable cost across the periods that benefit from using it.
Meet the Delivery Van
Cost: $50,000
Residual Value: $5,000
Useful Life: 5 years
Step 1: Buy the Van
On July 1, the company pays $50,000 cash for the delivery van.
Reveal the purchase entry
No.
The company still owns a resource that is expected to provide benefits for several years.
Debit Equipment $50,000
Credit Cash $50,000
Cash decreases once. Equipment increases once.
Step 2: Find the Depreciable Cost
Reveal the depreciable cost
Cost − Residual Value
$50,000 − $5,000 = $45,000 depreciable cost
That $45,000 will be allocated across the van's useful life.
Step 3: Calculate Annual and Monthly Depreciation
Reveal the calculation
$45,000 ÷ 5 years = $9,000 annual depreciation
Monthly depreciation:
$9,000 ÷ 12 = $750 per month
Step 4: Stop and Count the Months
The van was purchased on July 1, so it was used for:
July - August - September - October - November - December
Reveal Year 1 depreciation
6 months × $750 = $4,500 depreciation expense
Entry:
Debit Depreciation Expense $4,500
Credit Accumulated Depreciation $4,500
Only six months of the van's benefit belong in Year 1.
Step 5: Keep the Three Numbers Separate
Accumulated Depreciation = $4,500
Net Book Value = $45,500
Equipment remains recorded at its historical cost.
Accumulated Depreciation separately tracks how much of that cost has been allocated to expense.
Follow the Same Van Through Time
Reveal the full depreciation schedule
| Date | Depreciation Expense | Equipment | Accumulated Depreciation | Net Book Value |
|---|---|---|---|---|
| July 1, Year 1 | $0 | $50,000 | $0 | $50,000 |
| Dec. 31, Year 1 | $4,500 | $50,000 | $4,500 | $45,500 |
| Dec. 31, Year 2 | $9,000 | $50,000 | $13,500 | $36,500 |
| Dec. 31, Year 3 | $9,000 | $50,000 | $22,500 | $27,500 |
| Dec. 31, Year 4 | $9,000 | $50,000 | $31,500 | $18,500 |
| Dec. 31, Year 5 | $9,000 | $50,000 | $40,500 | $9,500 |
| June 30, Year 6 | $4,500 | $50,000 | $45,000 | $5,000 |
Notice the pattern:
Equipment stays at $50,000.
Accumulated Depreciation increases.
Net Book Value decreases.
At the end of the asset's useful life, book value reaches the expected $5,000 residual value.
What Depreciation Is NOT
Depreciation means the company pays cash every year.
No.
The $50,000 cash payment occurred when the van was purchased. Recording depreciation does not require another cash payment.
The Equipment account gets smaller each year.
No.
Equipment normally remains recorded at historical cost. Accumulated Depreciation is recorded separately.
Accumulated Depreciation is an expense.
No.
Depreciation Expense is an expense. Accumulated Depreciation is a contra-asset.
Net Book Value tells us exactly what the van is worth today.
No.
Net Book Value is:
Asset Cost − Accumulated Depreciation
It is an accounting amount, not necessarily current market value.
Income Statement vs. Balance Sheet
Can You Follow the Asset?
Cost: $36,000
Residual Value: $6,000
Useful Life: 5 years
Method: Straight-Line
1. Annual depreciation
2. Year 1 depreciation
3. Accumulated Depreciation at the end of Year 2
4. Net Book Value at the end of Year 2
Reveal the completed solution
Step 1: Depreciable Cost
$36,000 − $6,000 = $30,000
Step 2: Annual Depreciation
$30,000 ÷ 5 = $6,000 per year
Step 3: Monthly Depreciation
$6,000 ÷ 12 = $500 per month
October, November, and December = 3 months
3 × $500 = $1,500 Year 1 depreciation
| End of Year | Equipment | Accumulated Depreciation | Net Book Value |
|---|---|---|---|
| Year 1 | $36,000 | $1,500 | $34,500 |
| Year 2 | $36,000 | $7,500 | $28,500 |