Alright, so now let's discuss depreciation as an adjusting entry. We're going to go into depreciation a lot deeper in further videos, but at this point in the class, I just want to introduce you to the concept and how it relates to adjusting entries. So we've talked about deferrals and accruals quite a bit. Now we're talking about a depreciation adjusting entry. Okay. So when we talk about depreciation, we're breaking up the upfront cost. So you can imagine we buy some long-term asset that costs a lot of money, say $100,000 for some machine, but we don't use that machine just in 1 year. We're going to use it over a period of time, probably 10 years or something. So what we want to do is we want to break up that cost over its useful life. Okay? Over the machine's useful life, we want to break up that cost so it's consistent over the whole time we're going to use it. Right? It wouldn't make sense for us to take all the expense now and still benefit from the machine in future years. So we're trying to match that benefit that we're getting from the machine every year. We're trying to match that with the expense here. Right? So let's go ahead and do that.
Pop quiz. Depreciation expense is A, an expense, B, liability, C, asset, D, revenue. Now, I hope I haven't scared you with all these pop quizzes and when we're talking about expenses, but here we are talking about an expense, right? The times that it that we saw the word expense and it was an expense or it was not an expense, that's when we saw it said prepaid expense and it was an asset or accrued expense and it was a liability, right? Here it's just depreciation expense. This is a type of expense.
So let's think about the 2 important dates for recording depreciation. First, we have the asset purchase date. This is when we buy this long-term asset. Okay? So we're going to record the purchase of the asset at its what we call historical cost which is basically what we paid for it. Okay. So we're going to make a journal entry for what we paid for the asset. On January 1, 2000, the company purchased the Millennium Machine for $50,000 it is expected to last 10 years. Okay, so this 10 years that they told us, this is the useful life. Okay, remember we're talking about splitting up the cost over the useful life. Well, this is the useful life. It's going to be some estimate that the company makes. Okay. So they bought the machine for $50,000. Well, what happened is we have an asset. Right? We're going to debit our machinery account for $50,000 because we have an asset of $50,000 and we're going to credit cash, right, for 50,000. We paid for it. So now we have this asset, this long-term asset of 50,000. Notice we haven't taken any expenses yet, right? We spent all this money, but it's not an expense. We bought an asset. Cool? And now, time is going to be passing. Right? So we bought this on January 1st. We've been using the machine all year. And now it's December 31st. So you could imagine that the machine's been used up a little bit. Right? It had a 10 year useful life. We've used up part of that useful life. So we've got the adjustment date. We're going to record depreciation expense for the amount of the useful life that we used up, Okay? So this useful life, the way we're going to do this, in this case, right now, we're going to do a very simple method called straight line depreciation, a very simple one and that's what we're going to do is we're going to take the cost and divide it by the useful life And it'll tell us how much it'll how much depreciation we should take per year. So we've got $50,000 in cost, right? That's what it cost us divided by 10 years that tells us that we should take depreciation of $5,000 per year, right? So if you think about it, if we took depreciation expense of $5,000 per year, well that would match the $50,000 that it's worth, right? $5,000 per year for 10 years, that matches the $50,000 that we spent on the machine. So on December 31st, the company is going to record the 1st year of depreciation. Okay. So it's $5,000 per year and the 1st year has gone by. So we're going to debit depreciation expense, right? This increases the expense for $5,000, the amount that we've used up. Okay? And the credit here, so this is a new account that we haven't talked about yet, is called accumulated depreciation. Accumulated depreciation, okay? And that's going to get a $5,000 credit, okay? So all of our depreciation expense entries are generally going to look like this, where we're going to debit depreciation expense and credit accumulated depreciation, okay? So just before we get down to what this accumulated depreciation is, let's think about the balance in that account. Right now, we've only made one entry to accumulated depreciation, so the balance is $5,000, right? That's the total amount of depreciation we've taken up on this machine. Now the net book value, I guess we'll get back to net book value once we discuss what it is. So let's talk about accumulated depreciation a little more. Accumulated depreciation is a contra asset account. Okay? So contra asset, this is the first time we've talked about contra accounts. Okay? So when we talk about contra accounts, they have an opposite balance of the typical account of that type. So when we talk about assets, what type of balance do they usually have? Do they usually have a debit balance or a credit balance? Assets usually have a debit balance, right? Like cash or machinery. They generally have a debit balance. So a contra asset account is going to have a credit balance. Okay? So accumulated depreciation is a contra asset account because it lowers the value of a companion account, right? In this case, the machinery is going to be like the parent account and then accumulated depreciation is going to be tied to it, bringing it down to the correct book value. Okay? And we'll talk about that book value. So accumulated depreciation since companion account is the asset being depreciated, right? The machinery in this case. So we talked about straight line depreciation, how we come up with our depreciation expense, right? And that's where we take the purchase price, the cost, divided by the useful life, right? And this is a very simple one. Once we get into depreciation, we're going to learn different methods, a little more tricky methods. This is a very straightforward method. It gives us the same amount of depreciation every year and that's what we calculated up here, right? $50,000 in cost divided by 10 useful life gave us a depreciation expense of $5,000 per year. The other thing here is the net book value. Okay. Net book value sometimes called NBV, net book value. This is what the asset's worth after we consider all the depreciation, okay? So net book value is the purchase price, what it was originally worth minus all the accumulated depreciation, okay? So you can imagine each year we're taking depreciation expense, and that accumulated depreciation is going to keep increasing, right? Each year, we're going to take more depreciation, and it's going to be worth less and less. Okay? So in this case up here, our net book value would be the $50,000 original value of the machine minus the $5,000 in accumulated depreciation bringing our net book value down to $45,000. Okay, so now this asset, when we think about the asset on the books, the machinery is still going to show $50,000, but there's going to be this contra account right next to it that's lowering the value with this credit balance of $5,000, it's lowering the value of the machinery so that we have a net book value of $45,000. Okay? So there's that debit to machinery of $50,000 right here and this credit to accumulated depreciation of $5,000 brings it down to that asset having a $45,000 value. Cool? Alright. Let's pause here, and then we'll think of what happens as the years keep going by. Alright? Let's continue in the next
