Reserve for Depreciation

Reserve for Depreciation, commonly referred to as Accumulated Depreciation, is an accounting term that represents the cumulative sum of depreciation expenses that have been charged against a fixed asset since it was put into use. This reserve helps account for the wear and tear, obsolescence, or reduction in utility of an asset over time.

Detailed Definition

Reserve for Depreciation is maintained on the balance sheet as a contra asset account. Its role is to offset the cost of fixed assets and provide a more accurate picture of a company’s financial position by recognizing that certain assets decrease in value over time. By systematically allocating the cost of an asset over its useful life, businesses can match expenses with generated revenues, adhering to the matching principle in accounting.

Examples

Buildings: A company constructs a building for $500,000 and estimates its useful life to be 40 years. Each year, the company records $12,500 as depreciation expense. After 10 years, the Reserve for Depreciation (Accumulated Depreciation) on the building will be $125,000.
Machinery: A manufacturing firm purchases machinery for $100,000 with an expected useful life of 10 years. The firm applies straight-line depreciation, resulting in $10,000 depreciation expense annually. After 5 years, the Accumulated Depreciation for the machinery will be $50,000.

Frequently Asked Questions (FAQs)

Q: Why is Reserve for Depreciation important?
- A: It provides a realistic value of an asset by accounting for its reduction in value over time, which is essential for accurately assessing the company’s financial health.
Q: How is Reserve for Depreciation calculated?
- A: It is calculated by summing up the annual depreciation expenses for the asset over its useful life.
Q: What happens when the asset is fully depreciated?
- A: Once the asset is fully depreciated, the Reserve for Depreciation will equal the asset’s original cost, after which no further depreciation expense is recorded.
Q: Can Reserve for Depreciation be reversed?
- A: Generally, it is not reversed unless there is a disposal or sale of the asset, or an error was made in the initial depreciation calculations.
Q: What is the impact of Reserve for Depreciation on financial statements?
- A: It reduces the book value of assets on the balance sheet, hence providing a more accurate measure of net book value.

Depreciation: The systematic allocation of the cost of a tangible asset over its useful life.
Straight-Line Depreciation: A method of depreciation where the asset’s cost is uniformly spread over its useful life.
Contra Account: An account that reduces the balance of a related account; in this case, the asset account.
Useful Life: The estimated period over which an asset is expected to be used by a company.

Online Resources

Suggested Books for Further Studies

“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield.
“Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso.
“Financial Accounting: An Introduction to Concepts, Methods and Uses” by Roman L. Weil, Katherine Schipper, and Jennifer Francis.
“Principles of Accounting” by Belverd E. Needles Jr. and Marian Powers.

Fundamentals of Reserve for Depreciation: Accounting Basics Quiz

### What is Reserve for Depreciation also known as? - [ ] Capital Depreciation - [x] Accumulated Depreciation - [ ] Deferred Depreciation - [ ] Annual Depreciation > **Explanation:** Reserve for Depreciation is commonly referred to as Accumulated Depreciation, reflecting the total depreciation charged against an asset over its useful life. ### Which financial statement will you find Reserve for Depreciation on? - [ ] Income Statement - [x] Balance Sheet - [ ] Cash Flow Statement - [ ] Statement of Retained Earnings > **Explanation:** Reserve for Depreciation is found on the Balance Sheet as a contra asset account, reducing the total value of fixed assets. ### Depreciation applies to which of the following? - [ ] Land - [x] Buildings - [ ] Inventory - [ ] Cash > **Explanation:** Depreciation applies to tangible assets like buildings, machinery, and vehicles, but not to land, as land typically does not lose value over time. ### Which method evenly spreads the cost of an asset over its useful life? - [ ] Double Declining Balance - [x] Straight-Line - [ ] Units of Production - [ ] Sum-of-the-Years'-Digits > **Explanation:** The Straight-Line method of depreciation uniformly spreads the total cost of an asset over its useful life. ### What happens to the Reserve for Depreciation when an asset is sold? - [ ] It remains unchanged - [x] It is reduced by the amount of depreciation recorded for that asset - [ ] It increases - [ ] It is transferred to owner's equity > **Explanation:** When an asset is sold, the Reserve for Depreciation is reduced by the accumulated depreciation recorded for that asset. ### A company purchases machinery for $100,000 with a useful life of 5 years. Using straight-line depreciation, what is the annual depreciation expense? - [ ] $20,000 - [ ] $25,000 - [x] $20,000 - [ ] $15,000 > **Explanation:** Using straight-line depreciation, the annual depreciation expense is calculated as $100,000 / 5 years = $20,000. ### Why do companies use depreciation? - [ ] To increase the value of assets - [ ] To pay off liabilities - [x] To systematically reduce the value of assets over time - [ ] To allocate dividend payments > **Explanation:** Companies use depreciation to systematically allocate the reduction in value of assets over time due to wear, tear, and obsolescence. ### Can depreciation be recorded for intangible assets? - [ ] No, only tangible assets can be depreciated. - [x] Yes, intangible assets are amortized. - [ ] Only if they have a resale value. - [ ] Only if they are used internationally. > **Explanation:** Intangible assets are amortized rather than depreciated, applying similar concepts for the accounting of their costs over time. ### What happens to an asset’s book value after accumulated depreciation is accounted for? - [ ] It increases - [x] It decreases - [ ] It remains the same - [ ] It is eliminated > **Explanation:** An asset's book value decreases over time as accumulated depreciation is recorded, lowering the net book value of the asset. ### If a piece of equipment costs $50,000 and has accumulated depreciation of $30,000, what is its net book value? - [ ] $50,000 - [ ] $30,000 - [x] $20,000 - [ ] $80,000 > **Explanation:** The net book value of the equipment is calculated as the original cost minus the accumulated depreciation, which equals $50,000 - $30,000 = $20,000.

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Reserve for Depreciation