Accounting Treatment — Using a Provision for Depreciation Account

The second, more informative approach keeps the Asset Account permanently at original cost and accumulates all depreciation separately in a Provision for Depreciation Account (also called the Accumulated Depreciation Account) — this is the method most companies and larger firms actually use.

The journal entries.

1. On purchase of the asset (as before):

   Asset A/c ...Dr

   To Bank/Vendor A/c

2. At the end of each year, to record depreciation:

   Depreciation A/c ...Dr

   To Provision for Depreciation A/c

   (Being depreciation for the year credited to the Provision for Depreciation Account, instead of to the Asset Account)

3. To close the Depreciation Account:

   Profit and Loss A/c ...Dr

   To Depreciation A/c

Effect on the two accounts. The Asset Account now shows only purchases (and any additions) — its balance is always the original cost, unchanged by depreciation. The Provision for Depreciation Account, on the other hand, is a running total: it starts at zero, and its credit balance grows, year after year, by that year's depreciation — it always shows the total (accumulated) depreciation charged so far on the asset.

In the Balance Sheet. The asset is shown at its original cost, with the accumulated provision for depreciation deducted from it, so the reader can see both figures — original cost and accumulated depreciation — rather than only the net book value:

Asset at Original Cost ... XXX …