Depreciation Expense and Accumulated Depreciation effect on Shareholder's Equity

[DavidBrammer]

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

 

[mustafijurmba]

Balance Sheet

Liability Asset

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

 

[DrStrangeLove]

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.