When an organization incurs an expense whose benefit is immediately consumed, it charges it to the income statement of the same accounting period, but when a non-current asset is purchased which is to be used for a longer period of time (more than 12 months), the cost is charged to income statement over a longer period of time. This charge is known as depreciation. Depreciation is therefore the process of charging the cost of non-current assets to periods for which the organisation is expected to benefit from use of the asset. Depreciation is an application of matching principle. This means that the asset’s cost is being matched with the revenues earned by using the asset. For example, if an organization buys machinery for $2 million and expects it to have a useful life of 10 years, it will be depreciated over 10 years. Every accounting year, the organization will expense $200,000 (assuming that the organization adopts straight line method of depreciation). Various methods are used for calculating the amount of depreciation but broadly speaking, depreciation methods can be grouped into two categories: straight-line depreciation and accelerated depreciation.
The accounting entry for recording depreciation is as follows:
Debit Depreciation expense
Credit Accumulated depreciation