CFA - Recognition of Expenses in the Income Statement: Depreciation and Amortization

A lot of material has been written about how the depreciation of fixed assets is correctly reflected in the balance sheet, and it is not surprising, because the correctness of the organization’s reporting largely depends on this. Correct preparation of documentation allows analysts to form an accurate picture of the financial situation in the company, which, in turn, serves as the basis for making the right management decisions.

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Correctly reflected depreciation of fixed assets in the balance sheet allows you to accurately understand how large the organization’s profit is and how large amounts need to be included in the report. This determines what results the financial analysis will show, on the basis of which it will be possible to draw conclusions about the profitability of the enterprise. In addition, it is the depreciation of fixed assets in the balance sheet that is a significant factor. The financial leverage of the organization depends quite heavily on this.

Why is it so important how accurately depreciation is reflected on the balance sheet? The relationship is as follows: balance sheet information allows one to draw conclusions about how solvent the organization is. And it will be correct only if the depreciation in the balance sheet that accompanies the recapitalization of part of the company is correctly entered into the reporting.

The essence of depreciation

Note 1
The economic meaning of depreciation is that the cost of property acquired by a business entity is included in costs not as a lump sum, but in parts in accordance with one of the selected algorithms for its calculation.

For example, Shafran LLC purchased technological equipment in January of this year. In January, the accountant will take this equipment into account according to the drawn up acceptance certificate. And from February it will begin to include the costs of its acquisition in parts.

The amount of depreciation is determined by such indicators as:

• calculation method;
• the useful life (USI) of an object is the time when the organization intends to use this property in its activities.

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In Russian accounting practice, the calculation of depreciation on the assets of a business entity is an obligation enshrined in legislative acts in the accounting field. The procedure for calculating depreciation and its further attribution to the costs of an economic entity, as well as significant aspects of the regulatory regulation of its accounting process are disclosed in the following official documents:

• “Accounting for fixed assets” (PBU 6/01);
• “Accounting for intangible assets” (PBU 14/2007).

Next, we will consider in more detail the main aspects of accounting for depreciation of fixed assets and intangible assets.

General provisions

Issues of correct calculation and reflection of depreciation in the balance sheet were discussed in materials published by IFRS. From these publications it follows that depreciation is an accounting process. Its main task is to identify the useful life of the OS and distribute the price of the OS over this period. The concept of a depreciable object in these fundamental materials, which explain where depreciation is on the balance sheet, is based on assets, an assessment of their importance. From the point of view of experts, assets are what is a method for a company to make a profit in a given time period.

Analysts have suggested breaking down the objects to be studied into components to more accurately estimate depreciation. This made it possible to achieve higher calculation accuracy. In this case, a separate component must be depreciated separately if its price relative to the total cost is quite significant. In some cases, such an approach cannot be used, but if its use is realistic, then it becomes mandatory. However, this does not mean that the company’s assets should be divided, at least in a situation where there is no particular significance for the indicators reflected in the reports.

Useful life

When putting it on the balance sheet, the organization must determine the useful life of the asset or decide that it is impossible to determine it (clause 25 of PBU 14/2007).

Determine the useful life of intangible assets based on:

• the period during which the organization will own exclusive rights to the object. This period is indicated in the documents of protection (patents, certificates, etc.) or it follows from the law (for example, the exclusive rights of the database manufacturer are valid for 15 years (Article 1335 of the Civil Code of the Russian Federation));

• the period during which the organization plans to use the facility in its activities;

• the quantity of products or other physical indicator of the amount of work that the organization intends to obtain using this asset.

This is stated in paragraphs 25, 26 of PBU 14/2007.

If it is impossible to determine the useful life of an intangible asset, then there is no need to charge depreciation on it (clause 23 of PBU 14/2007). Such objects are called assets with an indefinite life (clause 25 of PBU 14/2007). Factors that interfere with determining the useful life are listed in the Explanations to the Balance Sheet and the Statement of Financial Results (clause 41 of PBU 14/2007). There is also no need to charge depreciation on intangible assets of a non-profit organization (clause 24 of PBU 14/2007).

Where do we start?

As follows from the mentioned IFRS document, first of all, the company decides in favor of choosing a specific amount - the initial price of the fixed asset. The choice is made by taking into account the significant components, of which each will have accrued depreciation in the balance sheet.

Example: If you want to look at an airplane, it can be divided into seats and body, ventilation system and engines. For each individual component, its own service life is determined. Depreciation is calculated for this period. In the balance sheet, the line reflects the indicators not for this component, but for the entire object as a whole, that is, for the aircraft. It is recommended to use this procedure both in the case when all components and the object as a whole are the property of the company, and when drawing up a lease agreement in which the object is listed on the balance sheet of the real owner, and not the tenant.

A separate story

A situation is possible when there is a certain fixed asset, divided into several components, and the analysis for each of them shows the same time intervals for reflecting depreciation in the balance sheet, and the theory also recommends using the same calculation methods. If there is such a coincidence, grouping of similar objects is allowed. The period of operation of the facility depends on:

• from the time interval planned by the company for using the facility;
• from the number of production units, similar, planned to be received during the operation of the facility.

Together? Separately?

In the case where it was decided to reflect depreciation for the components of an OS object (balance sheet item: OS = D 01 - K 02) separately, then a similar approach should be practiced for other parts of the object, which include elements that do not actually exist.

What scheme should be used to amortize such residuals? To do this, first analyze the consumer mode, estimate the approximate service life of all components of the OS object. The company has the right to separately deal with the depreciation of components whose original price relative to the cost as a whole represents an insignificant amount. At the same time, you need to remember: in fact, it is impossible to find where depreciation is reflected on the balance sheet, since according to accounting rules, in the 120th line you need to enter the cost, from which depreciation figures have already been subtracted.

Accounts, depreciation, rules: how does it work?

Another important point is related to which line of the balance sheet shows depreciation and where it should not be mentioned. Any organization adopts accounting policies. The chief accountant of the enterprise is usually responsible for its formation. The accounting policy must specify the method by which depreciation is calculated. This document consolidates the approach to the issue and regulates the accumulation of depreciation in the balance sheet line reflecting account 02 credit.

In general, a correctly completed balance sheet, as already stated above, does not directly reflect the amounts accrued as depreciation. The balance sheet instead records assets only as balances after depreciation amounts have been deducted. Account 01 is responsible for the original price of the objects, and credit 02 shows what will remain after wear and tear. The balance also contains an indicator of the difference between accrued depreciation and the initial price. This value is entered into the balance of account 02. Line No. 1150 is intended for this. The described principle was not introduced by chance. Typically, the people for whom financial statements are intended are interested in seeing how large the assets actually are at any given time.

Accounting and reporting

Where is depreciation shown on the balance sheet? In fact, it is taken into account in account 02, but is not reflected directly. The parameters of this account are such that it is considered regulating. This means that the account has no independent meaning. This status imposes certain restrictions: the use of material is allowed only if there is data from account 01, that is, the main one. It is on it that you can find what the cost of the object was at the beginning, which was later reduced by the amount of depreciation.

A separate group of assets - intangible - cannot be reflected in account 01; account 04 is intended for it. In general, the logic for calculating and reflecting changes here is similar, and depreciation in the balance sheet is shown by account 05, on which you can see how much depreciation accrued on the funds was. At the same time, it is not possible to directly see depreciation on the balance sheet. The data obtained during accounting calculations is not recorded on its own, since it is necessary to reflect assets on the balance sheet; depreciation is not such, but is important in the formation of costs and determination of costs associated with the production process.

Where is depreciation shown on the balance sheet?

It is impossible to see the amount of depreciation in the balance sheet, since in this accounting form all assets are reflected at their residual value, that is, minus depreciation. By debit account 01 “OS” the initial cost is fixed, depreciation is accrued on the credit account. 02, in the balance sheet they indicate the difference between the initial cost and accrued depreciation (credit balance of account 02) - the residual value in line 1150. This is the principle of constructing the balance sheet - the user of financial statements should see the real cost reflection of assets as of a certain reporting date.

So, depreciation of fixed assets is taken into account on the account. 02, which according to its characteristics is regulatory, i.e., does not have independent significance. It is used only in conjunction with main account 01, which takes into account the initial cost of depreciable property. The same algorithm is applied to intangible assets, the initial cost of which is fixed on the account. 04 and is regulated by the calculation of depreciation according to account. 05. Thus, it is impossible to see depreciation charges in the balance sheet. Accrued depreciation is not recorded in the balance sheet, since it is not an asset, but transfers the value of the property to production costs, participating in the formation of production costs.

Expenses and depreciation

The price of a product produced by a company directly depends not only on the input materials, but also on the wear and tear of the company’s property, which is included in the final cost. Based on this, in order to formulate costs correctly, you need to evaluate distribution costs, as well as the movement of funds through accounts linked to the main production processes. These are accounts numbered 20, 26, 44. All of them are accounting entries and allow you to estimate and reflect depreciation on the balance sheet, albeit indirectly. Information is placed on expense accounts DT 20, 26, 44, as well as KT 02.

Costs: fixed, variable, indirect, direct

What wear will be depends very little on production volumes and their changes. This allows you to classify depreciation charges as permanent expenses. The company decides in favor of a specific method for calculating funds and takes into account the same amount every month. This means that when producing hundreds of units of a product, deductions for depreciation are the same as when producing a thousand units.

According to the laws currently in force in our country, entrepreneurs are not limited in where and how to allocate costs. If you wish, you can qualify a specific article as indirect, and call another direct; you can do the opposite. Chapter 25 of the Tax Code is devoted to this, but there are no specific explanations or working rules in it yet. The taxpayer can independently make a decision and set up accounting in a way that is beneficial to him. In practice, depreciation charges are almost always classified as indirect costs.

How to make friends with the tax office?

But when tax officials come to an enterprise to conduct an audit, many of them like to make claims specifically under this article. An entrepreneur should think in advance about the motivation for the gradation he has introduced, and such that it satisfies the officials. Typically, tax auditors justify their interest by the fact that in any enterprise the costs on which the price of the final product depends are extremely significant, therefore classifying them as indirect is incorrect.

However, the most reliable method of freeing yourself from too much attention is to work out the organization’s accounting policies. You can add paragraphs to it to describe the mechanics of dividing direct and indirect costs. Additionally, it would not be superfluous to economically justify the decision. This will help resolve once and for all any disputes and doubts about the correctness of the company’s work. It will also help avoid disagreements within the organization. So, if depreciation of fixed assets is shown as an indirect expense on the balance sheet, it should be indicated as such.

Depreciation in accounting

Depreciation of fixed assets (FPE) and intangible assets (IMA) is calculated on the credit of account 02 “Depreciation of fixed assets” and account 05 “Depreciation of intangible assets”, respectively (Order of the Ministry of Finance dated October 31, 2000 No. 94n). But the debited account depends on what type of activity the organization is engaged in, on its structure and features of the Accounting Policy for accounting purposes, as well as on where the depreciable property is used. Depending on this, accrued depreciation can be reflected in the debit of the following accounts:

• 08 “Investments in non-current assets”;
• 20 “Main production”;
• 25 “General production expenses”;
• 26 “General business expenses”;
• 44 “Sales expenses”, etc.

Let us explain this with an example. Suppose a trade organization charges depreciation on a trademark: Debit account 44 - Credit account 05.

And if a manufacturing enterprise charges depreciation of equipment used in the manufacture of a certain type of product: Debit account 20 - Credit account 02.

If, for example, a truck is used exclusively during the construction of a building, depreciation on the vehicle will be included in the initial cost of such a building, which is formed on account 08: Debit account 08 – Credit account 02.

Reporting and depreciation

As has been said more than once above, when forming a balance sheet, it does not directly indicate the depreciation of an asset. Nevertheless, a thoughtful manager is usually interested in seeing the amounts allocated by the accounting department - if only for the sake of checking the correctness of the accountants' work. To get acquainted with the calculated indicators, you need to request reports on the financial performance of the enterprise.

In this document it will be possible to find the amounts of depreciation in various lines; this is determined by the characteristics of the activities of a particular organization. Let's say there are enterprises that use fixed assets in the production process for the main type of work, and they are not used anywhere else. Then line 2120, dedicated to sales and cost, will tell about depreciation. But if the enterprise has assets operated in trade, then the information can be found in line 2210, dedicated to expenses caused by commercial activities.

Special cases

In some organizations, operating systems are used in industries of an additional nature. As a rule, these are not common species. Some companies transfer fixed assets under a lease agreement, and it is believed that making a profit from rent is not the main source of income for the organization. Then depreciation will need to be taken into account in line 2350 of the balance sheet, that is, among other expenses.

Fixed assets can also be used for general business purposes. This is permitted if such permission was included in the enterprise's accounting policy. Depreciation amounts for such a company will be reflected in the balance sheet in line 2220.

Methods for calculating depreciation

In accounting, depreciation on intangible assets can be calculated:

• in a linear way;

• reducing balance method;

• by writing off the cost in proportion to the volume of products (works).

The organization must choose the method of calculating depreciation that will most accurately reflect the receipt of benefits from its use. If an organization cannot reliably determine the order in which benefits will flow, then use the straight-line method. Such rules are established by paragraph 28 of PBU 14/2007. Record your choice in your accounting policy.

An example of depreciation on an intangible asset. After commissioning, the use of the intangible asset is temporarily suspended

In March of this year, Alfa CJSC acquired exclusive rights to the trademark. The initial cost of exclusive rights, formed in accounting and tax accounting, is the same and amounts to 500,000 rubles. Alpha began using the trademark in April, so depreciation has been accrued on it since May. The useful life of a trademark is 5 years (60 months). Alpha calculates depreciation using the straight-line method.

The amount of monthly depreciation in accounting was: 500,000 rubles. : 60 months = 8333 rub.

In July, by agreement of the parties, the contract for the supply of products in which the trademark was used was temporarily suspended (until the beginning of next year). At the same time, the organization continues to accrue depreciation of the intangible asset (paragraph 2 of clause 31 of PBU 14/2007).

The calculation of depreciation charges for the period of useful use of the exclusive right to a trademark is presented in the table.

Theoretical aspects: what are fixed assets?

Of course, the issue of reflecting depreciation of fixed assets on the balance sheet of an enterprise and in the reporting generated by accountants is clear. But what, in principle, should be classified as fixed assets, and what cannot be classified in this category?

OS are those values ​​and property of the company that can be used as assets in production. They are needed to produce a product or provide a service, to perform work. In addition, it is customary to classify as OS such property that is necessary for the organization to be effectively managed.

OS is:

• equipment;
• equipment, including computing and measuring;
• building;
• Earth;
• equipment used in farming;
• livestock;
• planting perennial plants;
• roads.

OS is a capital investment in land, including various works that improve the quality of the territory from an agricultural point of view. This includes environmental management facilities and capital investments made in property received under a lease agreement.

The listed operating systems are not a complete list of all those that exist in all the diversity of companies in our world. In some organizations you can find quite specific operating systems. In general, the decision to include a particular item in the operating system is made by assessing how important the property is for production and management processes within the company.

Depreciation of fixed assets

The accounting policy of a business entity must necessarily fix the method of calculating depreciation used by it, choosing one of those named in this standard. Figure 1 gives a visual representation of possible options for calculating depreciation amounts in relation to fixed assets. Also in the presented figure you can see the formulas for the calculation.

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In accordance with the principles of continuity and comparability, the calculation of depreciation of an organization's property is carried out using one method from one financial year to another. For the first time, depreciation on an object related to depreciable property is accrued in the next month after it is taken into account. Depreciation must be calculated over the entire time period while the asset is in use and allows the organization to derive a positive economic effect from its operation. The cost of an asset that is subject to transfer of its value into expenses in parts over a certain period of time must be fully depreciated, except in cases where it is disposed of before the end of this period.

If certain conditions are met by a business entity, depreciation can be calculated using simplified methods, for example, an organization can write off the depreciation amount once (at the end of the financial year) by making one accounting entry. In relation to production or household equipment, it is also possible to use a simplified accounting option in the form of a one-time attribution of their cost to the expense accounts provided for this.

The chart of accounts in the Russian Federation provides for a special account for accounting for depreciation of fixed assets with code 02 and the same name - “Depreciation of fixed assets”

Example 1

Shafran LLC has assets on its balance sheet that are subject to depreciation: equipment of the production workshop (main production). On January 31, 2021, the accountant, when performing the month-closing procedure, accrued depreciation of this property in the amount of 17,000 rubles. In the accounting program you can see the following posting:

Debit 20 Credit 02 in the amount of 17,000 rubles.

And why is depreciation needed?

When a decision has been made to classify a certain object as a fixed asset, its value is determined. From quarter to quarter it becomes less by an amount defined as depreciation. Initially, a decision is made for the object on how long the operational period is. Throughout this period, reporting for each new quarter will contain updated indicators of the value of property included in the fixed assets.

Depreciation is calculated regardless of how large the organization's profit or loss is. Key concepts are the duration of the reporting period and the established depreciation rates for a specific fixed asset. But how deductions for depreciation are reflected in the financial statements depends on the method chosen in the accounting policy. Some companies use a linear method of reflecting data, while others have established a write-off of value, depending on the timing, proportional to the volume of goods produced by the company. You can also reduce balances.

Depreciation: fixed or variable costs

Since the amount of accrued depreciation of fixed assets practically does not depend on changes in production volume, it is classified as a fixed cost: no matter what method of calculating depreciation is adopted by the company, the amount of monthly deductions will remain unchanged both with the volume of output, for example, 100 units of product, and with production of 1000 units.

If the economist has no problems with the issue of the constant nature of such costs as depreciation, then attributing them to direct or indirect costs often involves enormous analytical work and the subsequent consolidation of the methodology for determining costs in the company’s accounting policy.

Rules and exceptions

Only those for which the operational period exceeds 12 months and the initial price is more than 40 thousand rubles can be classified as OS. In addition to fixed assets, intangible assets can be amortized. Property subject to depreciation represents capital investments aimed at generating profit. Some of them are additionally associated with lease agreements, and transfer for free use is also allowed.

But there are some exceptions to this rule (as well as to almost any rule). For example, if we are talking about a unitary enterprise, then depreciation will have to be charged on any property transferred by the owner for management or under operational management rights.

If there is a company that has found an investor for itself, then the property transferred by this person to the organization must be depreciated from the investor. This process is regulated by the investment agreement concluded at the beginning of cooperation. The investor accrues depreciation only during the period while the concluded agreement is in effect.

Natural resources, land, goods are objects that are not subject to depreciation. There is no need to calculate it for securities, as well as capital construction projects, work on which has not yet been completed.

Finally, there are fixed assets that are not recognized as depreciable. For example, if municipalities and government bodies do not participate in the transaction, then fixed assets transferred for free use cannot be called depreciable.

Accumulated depreciation

Definition 2

Accumulated depreciation represents the total cost of assets allocated as depreciation expense in a period. Accumulated depreciation is an account of assets that, at the closing balance, reduces the balance of the related assets.

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This account should not be used for valuation methods, but is used for distribution methods.

The value of long-lived assets, such as the value of buildings, may fluctuate according to market conditions. In this case, depreciation is not intended to track this value, but is driven by the need to gradually move the amount of assets as expenses into the income statement.

Thus, accumulated depreciation reflects the portion of the depreciable cost allocated over past periods.

The amount of accumulated depreciation is systematically increased, and the carrying amount reflects the assets being disposed of and subject to distribution in the future (at the end of the expected life) of objects. The cost of these objects includes the estimated liquidation value.