Definition of “Reserve for Depreciation”
A reserve for depreciation, often referred to as accumulated depreciation, represents the total amount of depreciation expense that has been recorded against a company’s fixed assets since those assets were put into service. This reserve is used to allocate the cost or value of an asset over its useful life, reflecting its usage and decline in value over time.
In accounting, the reserve for depreciation is typically recorded as a contra asset account on the balance sheet, reducing the gross amount of fixed assets to show their net book value. The net book value is the difference between the original cost of the asset and its accumulated depreciation.
Key Characteristics:
- Contra Asset Account: Accumulated depreciation is listed under assets but has a credit balance, thus reducing the total value of assets.
- Reflects Gradual Value Reduction: Depreciates cost over the asset’s useful life.
- Applicable to Tangible Fixed Assets: Buildings, machinery, office equipment, vehicles, etc.
Examples
- Building Depreciation: A company owns a building valued at $1,000,000 with an estimated useful life of 40 years. If it uses the straight-line method for depreciation, the annual depreciation expense would be $25,000. Over 10 years, the reserve for depreciation would grow to $250,000.
- Vehicle Depreciation: A business purchases a vehicle for $50,000 with a useful life of 5 years and zero salvage value. Using the straight-line method, it records $10,000 annually as depreciation expense. Thus, the reserve for depreciation after three years would be $30,000.
Frequently Asked Questions
Q: What is the difference between accumulated depreciation and depreciation expense?
A: Depreciation expense is the allocation of an asset’s cost for a specific period, typically annually, whereas accumulated depreciation is the total depreciation expense that has been recorded cumulatively over the asset’s life.
Q: Can land be depreciated?
A: No, land cannot be depreciated because it does not have a finite useful life. Only tangible fixed assets with useful lives, such as buildings or equipment, are eligible for depreciation.
Q: How is the reserve for depreciation reported in financial statements?
A: It appears on the balance sheet as a contra asset account, reducing the gross book value of the related fixed assets to reflect their net book value.
- Depreciation: The systematic allocation of the cost of a tangible asset over its useful life.
- Contra Asset Account: An account that offsets an asset account on the balance sheet.
- Straight-Line Depreciation: A method that spreads the cost of an asset evenly over its useful life.
- Useful Life: The period over which an asset is expected to be usable by a company.
- Salvage Value: The estimated residual value of an asset at the end of its useful life.
Online Resources
References
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
- “Financial Accounting” by Robert Libby, Patricia A. Libby, Frank Hodge
Suggested Books for Further Studies
- “Accounting for Dummies” by John A. Tracy
- “Depreciation: Accounting and Taxation” by Robert E. McNeill
- “Advanced Accounting” by Debra C. Jeter, Paul K. Chaney
Real Estate Basics: Reserve for Depreciation Fundamentals Quiz
### What does the reserve for depreciation represent?
- [x] The total amount of depreciation expense recorded for an asset since it was in service.
- [ ] The initial cost of an asset.
- [ ] The market value of an asset.
- [ ] The estimated salvage value of an asset.
> **Explanation:** The reserve for depreciation, also known as accumulated depreciation, represents the total amount of depreciation expense that has been recorded for a fixed asset since it was put into service.
### How is accumulated depreciation reported on the balance sheet?
- [ ] As a liability.
- [ ] As an equity account.
- [ ] As a positive asset.
- [x] As a contra asset account.
> **Explanation:** Accumulated depreciation is a contra asset account, which means it reduces the gross book value of the related assets on the balance sheet.
### What type of assets can be depreciated?
- [ ] Current assets.
- [ ] Intangible assets.
- [x] Tangible fixed assets.
- [ ] Inventory.
> **Explanation:** Tangible fixed assets like buildings, machinery, and vehicles are subject to depreciation, unlike current assets or intangibles.
### Using the straight-line method, how is annual depreciation expense calculated?
- [ ] By dividing the salvage value by the useful life.
- [ ] By multiplying the cost by the depreciation rate.
- [x] By dividing the depreciable cost by the useful life of the asset.
- [ ] By subtracting the accumulated depreciation from the cost.
> **Explanation:** The annual depreciation expense using the straight-line method is calculated by dividing the depreciable cost of the asset (cost minus salvage value) by its useful life.
### Is land depreciable under normal circumstances?
- [ ] Yes.
- [ ] Only if it loses value.
- [ ] Only in special circumstances.
- [x] No.
> **Explanation:** Land is not depreciable because it does not have a finite useful life like other tangible fixed assets.
### What happens to accumulated depreciation when an asset is fully depreciated?
- [ ] It is written off.
- [x] It equals the depreciable amount of the asset.
- [ ] It continues to accumulate.
- [ ] It is converted to an expense.
> **Explanation:** When an asset is fully depreciated, the accumulated depreciation equals the depreciable amount of the asset.
### Which of the following is NOT a method of depreciation?
- [ ] Straight-line method.
- [ ] Double declining balance method.
- [x] Market valuation method.
- [ ] Units of production method.
> **Explanation:** The market valuation method is not a recognized method of depreciation, whereas the other listed methods are commonly used.
### How does depreciation affect net income?
- [ ] It increases net income.
- [x] It decreases net income.
- [ ] It has no effect.
- [ ] It only affects balance sheet accounts.
> **Explanation:** Depreciation is an expense that reduces net income on the income statement.
### Can depreciation be reversed if an asset's value goes up?
- [ ] Yes, always.
- [ ] Sometimes.
- [x] No, depreciation expense already recorded is not reversed.
- [ ] Only if the increase is substantial.
> **Explanation:** Once depreciation expense is recorded, it is not reversed, even if the asset's market value increases.
### For tax purposes, depreciation is allowable on which type of property?
- [ ] Personal-use property.
- [ ] Vacant land.
- [x] Income-producing property.
- [ ] Non-residential property only.
> **Explanation:** Depreciation for tax purposes is allowable on income-producing property used in a business or income-producing activities.
