by Judith Lee
Companies depreciate assets so they can spread that large expense over several years. Business vehicles are an example of depreciable assets. The purchase creates an asset (debit) account on the balance sheet.
While there are several complicated methods of depreciation, the most common of them deal with the passage of time. Since several of those types can be complicated as well, the straight-line method is usually favored.
The basic method for figuring straight-line deprecation is to subtract any residual value from total cost and then divide the remainder by the years of useful life. Assuming a new car is purchased, the useful life should be at least 10 years. A 10-year-old car could conceivably be sold for at least $1,000. If the purchase price was $20,000, the yearly depreciation would be $1,900 (20,000 less 1,000 divided by 10).
Each year the journal entry would be the following:
Since cars depreciate quickly at first and then slow down with age, the sum-of-the-years-digits (SOY) or declining-balance (DB) methods of depreciation might be better choices for those who want to capture that initial loss on their financial statements. Thanks to the Internet, it's now very easy to figure the yearly depreciation.
A site called Calculator Soup has calculators for both of the above methods (plus many more). SOY might be the better method to use, since the depreciation will leave the salvage value at the actual amount. The DB method will overstate the salvage by quite a bit. Since it's easy to test out both methods using the linked calculators, everyone can see which is the best method for them. Calculator Soup also has a calculator for the straight-line method.
Using any of the other types of time-factor methods of depreciation would not change how to post the eventual sale of the car, at least as long as the actual salvage value remains. Otherwise, the final journal entry would have to account for the difference.
An interesting thing to note is that although accumulated depreciation is a credit account, it is listed below the assets on the balance sheet. Since it is technically on the "wrong side" of the accounting equation, it will always have a negative balance.
Continuing with the above example, what would happen in 10 years if the car is sold for $2,000? The vehicle has been fully depreciated and has a salvage value of $1,000. Clearly there is $1,000 gain in this transaction, but how would it be journalized?
There are two accounts related to the vehicle on the balance sheet: the asset and accumulated depreciation. Both of these would need to be reversed to remove them from the books. So how would the entry look? See the following example:
The above entry would remove the car and the accumulated depreciation from the balance sheet, add $2,000 to cash on the balance sheet and increase revenue on the income statement by $1,000. If the car were sold for less than salvage, the loss would be booked as a debit (Dr) instead of a credit (Cr). Just remember that all debits and credits must equal.