Depreciation Expense and Accumulated Depreciation effect on Shareholder's Equity

Joined
Oct 30, 2023
Messages
1
Reaction score
0
Country
Malawi
Good day,

I have a basic question about accounting for depreciation (and similar items like allowance for credit losses).

In my example, I have an asset worth 100$ that will be depreciated 10$ per year for 10 years. total shareholders' equity is 100$.

After the first year of using my asset, I have a net profit (excluding depreciation expense) of 10$.

My asset is clearly now worth 90$ because it has been in use for 1 year.

If I add this net income figure back to my shareholder's equity via retained earnings I would have 100$. An asset worth 90$ and retained earnings of 10$. To me, this makes sense.

If, however, I account for depreciation as an expense, I would have a net profit of 0$ whilst also having decreased the value of my asset on my balance sheet.

I would add this 0$ profit to my retained earnings resulting in 90$ shareholder equity.

After 10 years I would have 0$ in equity even though I have earned 100$ (assuming 10$ per year net earnings excl. depreciation expense) from the use of my asset that is at that point fully depreciated.

In effect, it seems to me that my shareholder's equity is charged twice. 1) From the decreased amount of retained earnings due to the depreciation expense and 2) from the accumulated depreciation account (contra asset).

Is there a mistake in my reasoning?

Looking forward to your response
David
 
Joined
Oct 17, 2023
Messages
7
Reaction score
0
Country
Bangladesh
Balance Sheet

Liability Asset

Shareholder Equity 100 <> Asset 100
Net profit 10
Allowance for Dep 10
 

DrStrangeLove

VIP Member
Joined
May 27, 2022
Messages
169
Reaction score
28
Country
United States
Good day,

I have a basic question about accounting for depreciation (and similar items like allowance for credit losses).

In my example, I have an asset worth 100$ that will be depreciated 10$ per year for 10 years. total shareholders' equity is 100$.

After the first year of using my asset, I have a net profit (excluding depreciation expense) of 10$.

My asset is clearly now worth 90$ because it has been in use for 1 year.

If I add this net income figure back to my shareholder's equity via retained earnings I would have 100$. An asset worth 90$ and retained earnings of 10$. To me, this makes sense.

If, however, I account for depreciation as an expense, I would have a net profit of 0$ whilst also having decreased the value of my asset on my balance sheet.

I would add this 0$ profit to my retained earnings resulting in 90$ shareholder equity.

After 10 years I would have 0$ in equity even though I have earned 100$ (assuming 10$ per year net earnings excl. depreciation expense) from the use of my asset that is at that point fully depreciated.

In effect, it seems to me that my shareholder's equity is charged twice. 1) From the decreased amount of retained earnings due to the depreciation expense and 2) from the accumulated depreciation account (contra asset).

Is there a mistake in my reasoning?

Looking forward to your response
David
I think your example is missing something. Your firm starts off with a depreciable asset that cost $100, and your shareholder equity is $100. That means your firm has no liabilities. If you got $10 in operating profit before depreciation expense, you must have had a net $10 increase to assets in some form. Otherwise you couldn't have had any revenue to make the $10 operating profit. It wasn't from a decrease in liabilities. There's your missing $10.
 

Ask a Question

Want to reply to this thread or ask your own question?

You'll need to choose a username for the site, which only take a couple of moments. After that, you can post your question and our members will help you out.

Ask a Question

Members online

Forum statistics

Threads
11,666
Messages
27,639
Members
21,470
Latest member
Batty

Latest Threads

Top