Depreciation explained

What is depreciation? How to calculate depreciation? Depreciation, amortization and CapEx tutorial. Overview of depreciation accounting (concept and application), and related topics such as accumulated depreciation, book value, residual value, historical cost, fixed assets, amortization, useful life, capital expenditures (CapEx) and capitalization. Intended for students and business people at both entry and advanced levels.

⏱️TIMESTAMPS⏱️
0:00 Introduction
0:20 What is depreciation
1:22 Depreciation definition
2:50 Useful life of an asset
4:05 Accounting for depreciation
4:52 Depreciation journal entries
5:25 Historical cost of an asset
6:20 Straight-line depreciation vs other depreciation methods
7:26 Residual value of an asset
7:55 Depreciation vs amortization

Depreciation is the accounting process of allocating the cost of tangible assets to current expense in a systematic and rational manner in those periods expected to benefit from the use of the asset.
That last part of the sentence “in those periods expected to benefit from the use of the asset” is called the matching principle: expenses should be recorded during the period in which they are incurred.

Depreciation is often referred to as a non-cash expense. The cash was spent when we bought the asset, depreciation allocates the value of the asset over the years in which we use it.

As you can see from the journal entries in the video, depreciation is not about putting money aside for buying a new asset once the current one is at the end of its lifetime. Depreciation takes the amount you spent to buy the asset, and allocates a proportionate amount to each of the periods of its useful life. Hopefully the company that we are looking at generates very profitable products or services with the building, machine and truck that they are using, and the cash generated with selling these products and services can be used in the future to buy replacements for the assets that are at the end of their lifetime.

What can you include in the value of the asset on the balance sheet when you buy it? This depends on the accounting rules that your company applies, which in turn depends on the country where you are located and whether you are accounting for tax or statutory purposes, or for reporting to the stock market. Generally, what you pay for the asset to the supplier, as well as transportation and installation cost can be capitalized. Capitalization means recording things as fixed assets on your balance sheet.

It’s important to have consistency of method in the way you depreciate assets. A company could change from linear depreciation of its trucks to a depreciation based on units of production (which in the case of trucks would be mileage), if that presents a more fair and accurate representation of the value of the assets. However, you can’t be flipping back and forth between methods randomly every year, as that would adversely impact the year-over-year comparisons, and it would not come across as very systematic and rational per our definition earlier on.

What is the difference between depreciation and amortization? The concept is the same, but depreciation and amortization are applied to different types of assets. You depreciate a tangible asset, and amortize an intangible asset. The threshold levels (minimum total spend) and capitalization criteria for intangible assets tend to be a lot more stringent than those for tangible assets.

Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investment decisions. Philip delivers training in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

[NeonKue]

Geez, why the hell do we need live Zoom class sessions and school in general when you could get it easily broken down in this video? Thanks, now I get it after all my years in high school and college lol

[unknowninfinium]

Holy shit dude, did you just explained this far easily than all the accounting lectures I have ever met in my life?

Wow just wow.

One dount however, what is depreciation allowance?

[DanDylan]

There is not so many comments that I can see here... but... honestly... without your videos I would never ever understood and finished The Intelligent Investor book... I hope you'll have much more subs in the future! Thank you so much!

[amanrashid]

3 hours before a big test and I know more about this topic then the others who payed attention in class.

[khabouri]

Thank you very much for explaining the accounting jargon 😊 looking forward to more videos. Thank you once again.

[ps]

Really useful video. Especially at 3:38 which was always a question for me - what happens after the useful life of the asset.

[austinnhernandezz]

I learn a lot by watching your videos, but it's also a nice treat to read the questions and your answers.

Thank you.

[JanineKazmi]

You explained this so simply!! Thank you very much

[migs_frias]

thanks so much for this short yet precise and on point

[KatieYT]

Thanks very easy to understand. My question would be:

When purchasing a Lorry for $100.
1. Cr Cash $100 & Dr NCA $100
2. Dr depreciation yr 1 $50 & Cr Accumulated depreciation yr 1 $50.
Dr depreciation yr 2 $50 & Cr Accumulated depreciation yr 2 $50
3. Cr NCA $100 & Dr Disposal $100
4. Cr Disposal $100 & Dr accumulated depreciation $100

These accounts then have value of $0 except of depreciation having still Dr balance of $100. Do you leave it like that or there is a transaction we should do ?

[LeserDrac]

I've watched this. Its very useful. I gave you a like. It explained depreciation concept as element of finance analysis of an asset. The element is *the value of the asset* after being purchased and used. Alas, I am still wondering why we need depreciation analysis and how it benefits us. 7.5/10 video (Y)

[dolevmazker]

nice video man, gonna watch all your videos to further understand how to read financial statements and to help me in corporate finance, and valuation. Thanks in advance

[alexshum]

This video is very useful to me. Thank you.

[KrishanSingh-gzop]

As due to depreciation the assets side of the balance side are reduced by the amount of depreciated value, So which particular item is reduced on the liability side so that the balance sheet stays in balance? For eg. Let's say a company has a total assets of $1000 & it depreciated that asset by $100 dollar, So at the end the company will have $900 worth of assets, but which particular item on the liability side will be reduced by $100 to maintain the balance of balance sheet.

[richardsalley]

Now I'm struggling a little with this. You say that depreciation expenses are shown as an expense on the company's income statement.
I'm looking at the income statement of Walmart for 2012, and I don't see a "depreciation expense" anywhere on the Income Statement.
However, I see a depreciation write down on the balance sheet instead.
No only that, but I still fail to understand how "depreciation and amortization" is added to cash from operating activity, that in effect increases "free cash flow" overall?
I wish I could get a little more clarity on this matter, where it is explained using real company financial statements.

[amberlycoleman]

Thank you for your videos, my question is what happens if something doesn't live up to it's expected life? Like if you buy a truck for 1000 and estimate that it will last 4 years but it only last's for two, would you then go back to your previous reports and change the amount or would the last report just have a larger amount than the other ones?

[jamesperry]

*Love the graphics.* _Thanks for the useful explanation._

[shalsteven]

Still don't get it. Let say a company buy a machine using cash for $100, 000 therefore we record that the cash decrease 100k and asset/tools increase 100k.

Then why we decrease the operating profit by this depreciation? Don't we already have decrease the cash in the beginning?

[GraniteInTheFace]

4:06
What is the significance of adjusting the depreciation schedule? What benefit is there to divide the depreciated amount over another 10 years?

[KrishanSingh-gzop]

I know that current book value of an asset = purchasing cost - Accumulated depreciation. And if I sell the asset above it's purchasing cost then it will recognized as profit. But if I sell the asset above its current book value will that also be termed as profit?

For eg. Let's say purchasing cost = 10000
Accumulated depreciation = 4000
Current book value = 10000-4000=6000.

So will I earn profit if I sell the asset above 6000. If yes, then what is the difference between profit above book value (6000) and profit above purchase cost (10000)?