Fixed assets are capitalized when they are purchased. No expenses hit the income statement during the purchase. An asset account is debited and the cash or payables accounts are credited. This capitalization concept is based on the matching principle, which states that we need to match expenses with the revenues they help generate. If we expensed capital assets, we would be recording all of the expenses for an asset that will last five plus years in the year of the purchase. This doesn’t match the revenues or expenses. Depreciation is a way to fix this problem. It takes the depreciable cost of an asset and allocates it over the useful life. This way the expense actually reflects the income produced from the asset in that period.
In a Nutshell :
- Depreciation ties the cost of using a tangible asset with the benefit gained over its useful life.
- There are many types of depreciation, including straight-line and various forms of accelerated depreciation.
- Accumulated depreciation refers to the sum of all depreciation recorded on an asset to a specific date.
- The carrying value of an asset on the balance sheet is its historical cost minus all accumulated depreciation.
- The carrying value of an asset after all depreciation has been taken is referred to as its salvage value.