Depreciation expense: equipment is the income statement account that records the part of the cost of a company's equipment charged to the current accounting period. It is a specific use of the broader depreciation expense account, kept separate so that a business can see how much of its depreciation relates to machinery, tools, computers and similar items, as opposed to buildings, vehicles or furniture.
The account is the expense side of a pair. Every time it is debited, the matching credit goes to Accumulated Depreciation: Equipment, the contra-asset account that reduces the equipment balance on the balance sheet. Depreciation expense: equipment is a temporary account that is closed to retained earnings or owner's capital at year-end, while accumulated depreciation carries forward until the equipment is disposed of.
Depreciation expense on equipment in plain terms
A print shop that buys a $60,000 press expects to use it for years. It would be odd to say the shop lost $60,000 in the month it bought the press and nothing after that. Instead, the cost is spread over the years the press will be printing jobs and earning money.
The slice of cost counted in each year is the depreciation expense. It does not involve paying anyone; the cash left the business when the press was bought. The expense is simply a way of matching the cost of the machine with the years in which it helps the business earn revenue.
Recording the expense
Depreciation is usually recorded through adjusting entries at the end of each month or year. The entry is:
- Debit Depreciation Expense: Equipment.
- Credit Accumulated Depreciation: Equipment.
The amount depends on the method chosen. Take the $60,000 press with a $6,000 salvage value and a six-year useful life. Under the straight-line method, the annual expense is $54,000 divided by six, or $9,000. Under the double-declining balance method, the rate is twice the straight-line rate, one-third a year, applied to the carrying value: $20,000 in year one and $13,333 in year two, with the charge stopping once carrying value reaches the $6,000 salvage value. The units-of-production method would instead base the expense on the number of impressions printed.
Where it appears in the statements
Where depreciation on equipment is reported depends on how the equipment is used. Depreciation on factory machinery is a product cost: it is part of manufacturing overhead, is applied to inventory and reaches the income statement through cost of goods sold when the goods are sold. Depreciation on office computers or showroom fixtures is a period cost and is reported within operating expenses, such as selling or administrative expenses.
Because depreciation reduces profit without using cash, it is a noncash expense. In the operating section of the statement of cash flows prepared under the indirect method, it is added back to net income.
Book and tax depreciation
For US federal income tax, equipment is depreciated under the modified accelerated cost recovery system, which sets recovery periods and methods by asset class, and businesses may also be able to expense qualifying equipment immediately under Section 179 or claim bonus depreciation. As a result, depreciation for tax purposes in a given year often differs from the amount in the financial statements. When tax depreciation runs ahead of book depreciation, the difference usually creates a deferred tax liability, which reverses in later years when book depreciation exceeds tax depreciation.
Judgment and estimates
Depreciation expense rests on estimates of useful life and salvage value. If those estimates change, for example because a machine will be replaced earlier than planned, the remaining carrying value is depreciated over the revised remaining life from that point on. Past expense is not restated. When equipment is bought or sold partway through a year, companies either calculate depreciation for the exact number of months held or apply a simple convention, such as a half year of depreciation in the year of purchase and the year of sale, applied consistently across all equipment. Equipment that is still in use after it is fully depreciated stays on the books at cost with an equal amount of accumulated depreciation, and no further expense is recorded. If equipment suffers a sudden loss of value, an impairment test may require a separate write-down in addition to normal depreciation.