The Adjusting Process LO 2d – Recording Depreciation of Fixed Assets

LO 2 Adjusting Entries This shows the unadjusted trial balance for NetSolutions before any adjusting entries have been prepared.

LO 2 Depreciation Expense Fixed assets, or plant assets, are physical resources that are owned and used by a business and are permanent or have a long life. As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation. Fixed assets, or plant assets, are physical resources that are owned and used by a business and are permanent or have a long life. Examples of fixed assets include land, buildings, and equipment. Fixed assets such as equipment are used to generate revenue, much like supplies are used in the generation of revenue. Unlike supplies, there is no visible reduction in the quantity of equipment. Instead, as time passes, equipment starts to lose its ability or capacity to provide useful services.

LO 2 Depreciation Expense All fixed assets, except land, lose their usefulness and , thus, are said to depreciate. As a fixed asset depreciates, a portion of its cost should be recorded as an expense. This periodic expense is called depreciation expense. All fixed assets, except land, lose their usefulness. As an asset loses its usefulness, or depreciates, while being used to generate revenue, a portion of its cost should be recorded as an expense. This periodic expense is called depreciation expense.

LO 2 Depreciation Expense The fixed asset account is not decreased (credited) when making the related adjusting entry. This is because both the original cost of a fixed asset and the depreciation recorded since its purchase are reported on the balance sheet. Instead, an account entitled Accumulated Depreciation is increased (credited). Instead of crediting the asset account for the decline in usefulness, we credit a contra account called Accumulated Depreciation for the credit. This maintains the original cost of the fixed asset in the records. Both the asset’s cost and the balance of accumulated depreciation are reported on the balance sheet. Accumulated Depreciation is called a contra account, or contra asset account, because it is deducted from the related asset account on the balance sheet.

LO 2 Depreciation Expense Accumulated depreciation accounts are called contra accounts, or contra asset accounts.

LO 2 Depreciation Expense Normal titles for fixed asset accounts and their related contra asset accounts are: This lists the normal, or typical, titles for fixed asset accounts and their related contra asset accounts. Land is not depreciated, so there is no contra account for land. Each of the fixed asset accounts that are depreciated are associated with a contra asset account. The name for these contra accounts takes the format Accumulated Depreciation—[asset name].

LO 2 Depreciation Expense NetSolutions estimates the depreciation on its office equipment to be $50 for the month of December. NetSolutions has purchased office equipment that must be depreciated. They estimate the depreciation expense of $50 per month for the office equipment.

Accounting Equation Impact LO 2 Depreciation Expense Assets = Liabilities + Stockholders’ Equity (Expense) Accounting Equation Impact A contra account always has the opposite balance of the account it is contra to. Assets normally have debit balances; therefore, accumulated depreciation normally has a credit balance because it is a contra asset. This is the first month of operation for NetSolutions, so there is a zero balance in Accumulated Depreciation. The first step in recording depreciation is to prepare a journal entry debiting Depreciation Expense for the expired cost of the asset. The contra account, Accumulated Depreciation—Office Equipment, is credited for $50. increase increase

LO 2 Depreciation Expense The difference between the original cost of the office equipment and the balance in the Accumulated Depreciation—Office Equipment account is called the book value of the asset (or net book value). It is computed as shown below. Book Value of Asset = Cost of the Asset – Accumulated Depreciation of Asset Book Value of Off. Equip. = Cost of Off. Equip. – Accum. Depre. of Office Equip. Book Value of Off. Equip. = $1,800 – $50 Book Value of Off. Equip. = $1,750 NetSolutions’ balance sheet reports the office equipment at cost, less the accumulated depreciation. The net balance of $1,750 is called the book value, or the carrying value, of the office equipment.