Question

Why is depreciation considered a non-cash item? How is depreciation recorded on the general ledger? How is the original asset recorded on the general ledger?

Answer 1

Let's try to understand depreciation first. The value of the assets which are having limited useful life gets eroded over time due to efflux of time or use or technological obsoloscence and such erosion is called depreciation.

For example: If a machine worth $1MN is purchased and put to use in the current year with useful life of 10 years, then depreciation should be charged over 10 year term to ensure compliance with the matching principle of accounting which requires that revenues and the costs during a particular accounting period should be matched. As the asset is helping the business generate revenue over a period of 10 years, cost of asset (in the form of depreciation) should also be spread over 10 years instead of accounting for the full cost of the asset as expnese in the year1 itself.

Now coming to the specific sub parts of the questions:

1. Depreciation is non-cash item because the cash outlow is on account of purchase of asset intially, when depreciation gets charged (to comply with matching principle) on the asset but there is no corresponding cash outflow.

2. Accounting for the depreciation every year is as under:

Depreciation expense Dr

Accumulated Depreciation Cr.

Depreciation expense account hits the P&L account and accumulated depreciation balance is deducted from the value of the asset in the balance sheet.

3. At the time of asset purchase (assuming cash purchase) accounting entry is :

Asset (Plant/Machinery etc.) Dr

Cash Cr.

Asset balance gets reflected in the balance sheet year on year after deducting the balance in accumulated depreciation account.

Do let me know if you need any clarification.