Depreciation refers to the amount of value lost by an asset, which is used for business purposes due to wear and tear over the time it is used. The accounting entry for depreciation is represented on both the balance sheet of a business and on its income statement. On the income statement, the entry for depreciation is a debit account that represents the amount of depreciation the asset has suffered in that accounting period. By contrast, the entry on the balance sheet is a credit and represents the amount of depreciation that has accumulated on the asset up to that point.
Any asset that is used by a business, such as a car, a computer, or a building, suffers a loss of value as it is being used over a period of time. That value loss, known as depreciation, is an important principle for businesses to understand when it comes time to compile their accounting. The entry for depreciation is based on the matching principle, by which the revenue earned by an asset is offset by the value lost over time.
On a balance sheet, the entry for depreciation accumulates over time. It is known as a contra account because it works against the cost of the depreciation and is usually filed under the heading of property, plant, and equipment. The entry is a credit on the balance sheet, and it carries over from one period to the next. For example, a business vehicle that has been depreciated for five years at a rate of $200 US Dollars (USD) per year would have an accumulated depreciation of $1,000 USD on the balance sheet.
By contrast, the entry for depreciation on an income statement, which determines the taxes a business must pay, is a debit account and is only temporary. The yearly amount of depreciation is known as the depreciation expense. This amount zeroes out each year and does not carry over. Using the example above, the depreciation expense for the vehicle in the first year would be $200 USD, and it would still be $200 USD in the second, third, and so on.
The amount of depreciation on an asset is calculated using several methods, with the two general methods being the straight-line method, in which the same amount is depreciated each year, and accelerated depreciation, in which a larger amount is depreciated the first year with diminishing amounts depreciated each succeeding year. It is important to note that the depreciation expense entry does not represent a loss of cash for the business, but a loss of income. In addition, the cost of the asset as listed on the balance sheet after depreciation may not be representative of the asset's actual market value, but instead is simply an attempt, through accounting, to balance cost and expense.