Creating Provision for Depreciation Account/Accumulated Depreciation Account

The Concept: Why Keep a Separate Provision for Depreciation?

When you charge depreciation directly to the asset account, the asset's book value keeps falling each year. After a few years, you cannot tell from the balance sheet what the asset originally cost — that information is lost. The Provision for Depreciation method solves this problem.

Under this method, the asset account is never touched after the purchase entry. It stays at its original cost forever. All the depreciation accumulated over the years is collected in a separate account called Provision for Depreciation Account (also called Accumulated Depreciation Account). This account grows year after year as more depreciation is added to it.

The Two Key Characteristics

1. The asset account continues to appear at its original cost year after year over its entire useful life.
2. Depreciation is accumulated in a separate account instead of being adjusted in the asset account at the end of each accounting period.

Journal Entries Under This Method

1. For recording purchase of asset (same as always)

2. Two entries at the end of each year

(a) For crediting depreciation amount to provision for depreciation account

(b) For charging depreciation to profit and loss account

Balance Sheet Treatment

In the balance sheet, the fixed asset continues to appear at its original cost on the asset side. The depreciation charged till that date appears in the Provision for Depreciation account, which can be shown in either of two ways:

• On the liabilities side of the balance sheet (as a separate item), or
• By way of deduction from the original cost of the asset concerned on the asset side of the balance sheet.