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Lesson 11 of 13The Accounting Cycle: Service Business
Unit 2 · Lesson 11 of 13

Depreciation

Depreciation spreads the cost of a fixed asset over the years it's used, instead of expensing its full cost the moment it's purchased.

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Key things to remember

  1. 1Depreciation allocates a fixed asset's cost to the periods it's used; it's an expense on the income statement.
  2. 2Accumulated Depreciation is a contra-asset account; Book Value = Cost − Accumulated Depreciation.
  3. 3Straight-line: Annual Depreciation = (Cost − Salvage Value) ÷ Useful Life — same amount every year.
  4. 4Declining-balance: Depreciation = Book Value at start of year × Rate — larger amounts in early years, salvage value ignored in the formula.
  5. 5Depreciation is called Capital Cost Allowance (CCA) for income tax purposes.

A delivery truck helps earn revenue for years, not just on the day it was bought — so expensing its entire cost immediately would badly distort net income for that one year, and overstate it for every year after. Depreciation is the allocation of the cost of a fixed asset to the fiscal periods in which it is used. Depreciation is an expense and appears on the income statement, spreading the asset's cost across its useful life in a way that better matches the expense to the revenue it helps generate — the matching principle in action.

yearsbook valuestraight-linedeclining-balanceYear-by-year expense (cost $5 000, salvage $500, life 5 yrs, rate 40%)Yr 1SL: 900Yr 2SL: 900Yr 3SL: 900Yr 4SL: 900Yr 5SL: 900
Fig 1Straight-line spreads cost evenly; declining-balance front-loads depreciation into the early years.

The Contra Account: Accumulated Depreciation

A contra account reduces the value of another account. Depreciation is never subtracted directly from the asset account itself — instead, it builds up in a separate contra-asset account called Accumulated Depreciation, which is subtracted from the asset's cost when the balance sheet is prepared. Book value is the cost of an asset minus the accumulated depreciation — it's what remains "on the books," not what the asset could actually be sold for.

Straight-Line Depreciation

Straight-line depreciation allocates the same amount of depreciation to each fiscal period — the simplest and most common method for a service business's equipment.

Original cost − salvage value = total write-off
The numerator, cost minus salvage value, is the total amount that will ever be depreciated over the asset's whole life — the "total write-off." Straight-line just divides that total evenly across the years.

Declining-Balance Depreciation

Declining-balance depreciation allocates a greater amount of depreciation to the first years of an asset's life. Instead of applying a fixed rate to the original cost every year, it applies a fixed percentage rate to the asset's current book value, which shrinks every year — so the dollar amount of depreciation shrinks too, year after year. Notice that salvage value is not subtracted before applying the rate under this method.

Capital Cost Allowance
Depreciation is called Capital Cost Allowance (CCA) for income tax purposes. The CRA sets its own fixed rates and rules for CCA by asset class, which are often different from the depreciation rates and methods a business chooses for its own financial statements.
Straight-lineDeclining-balance
Formula base(Cost − Salvage) ÷ LifeBook value × Rate
Yearly amountSame every yearLarger in early years, shrinks over time
Salvage value used?Yes, subtracted firstNot subtracted (ignored in the calculation)

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
Trillium's equipment cost $6,000, has an estimated salvage value of $600, and a useful life of 5 years. Calculate annual straight-line depreciation and the book value after year 1.
Example 2
Trillium's truck cost $9,000 and is depreciated at 20% declining-balance. Calculate depreciation for year 1 and year 2, and find book value after each year.
Example 3
A $15,000 machine has a $3,000 salvage value and a 4-year useful life. Prepare a straight-line depreciation schedule for all 4 years.

Where marks get lost

  • Subtracting salvage value before applying the declining-balance rate — declining-balance ignores salvage value in its yearly calculation entirely.
  • Debiting the asset account directly for depreciation instead of crediting the contra account, Accumulated Depreciation.
  • Forgetting that declining-balance depreciation applies the rate to the current book value each year, not the original cost every year.
  • Confusing book value with market value — book value is just cost minus accumulated depreciation on the books; it has nothing to do with what the asset could sell for today.
  • Letting straight-line depreciation continue past the point where book value equals salvage value — depreciation stops once the asset is fully written down to salvage value.

Flashcards 8

Depreciation
Contra account
Book value
Straight-line depreciation
+ 4 more

Practice

1
A machine costs $20,000, has a $2,000 salvage value, and a 6-year useful life. Find annual straight-line depreciation.
$
2
A vehicle with a book value of $12,000 is depreciated at 25% declining-balance this year. Find this year's depreciation.
$
3
Which account is credited when recording depreciation?
4
What is book value?
5
Compared to straight-line, declining-balance depreciation...
6
What is depreciation called for income tax purposes?
7
A $9,000 truck is depreciated 20% declining-balance. What is book value at the end of year 2 (after $1,800 in year 1 and $1,440 in year 2)?
$
8
Why does straight-line depreciation subtract salvage value before dividing by useful life?

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