Buying assets takes cash out of the companyâ€™s balance sheet, which should be registered as a cost in the P&L account of the company. Since the benefits from the assets will come in the future, matching principle asks us to incur the cost of buying the assets in future with the incoming revenues. Letâ€™s take a note of this and remember some of our lessons in Accounting.
How to put these costs of buying the assets in our statements?
These costs are transformed into assets and are incurred through the depreciation when the asset starts generating revenue.
Letâ€™s see this scenario from our model:
- In 2005, $10 millions were spent on fixed assets
- Cash will decrease by $10 million from the balance sheet
- Assets will increase by $10 million in the balance sheet
- Assets = Liabilities + Equity equation still holds
But to take care of the cost of buying asset we recognize cost through a term called depreciation. This depreciation decreases the assets by the amount of depreciation. This depreciation entry goes both in P&L and the Balance sheet.
- This depreciation is added into the last yearâ€™s accumulated depreciation to get the depreciation for the year
Profit & Loss Account:
- Depreciation amount is recognized in the Profit & Loss account.
Assuming the life of assets as 10 years in the model, I have depreciated it uniformly for 10 years, which gives us the depreciation for FY 05 as $ 1 million.
In 2006 assets worth $ 85 million are purchased apart from the $ 10 million purchased last year.
Total depreciation for FY 06 = Depreciation of $ 10 million asset purchased in FY 05 ($1million)
+ Depreciation of asset purchased in 2006 ($ 8.5 million)
=$ 9.5 million
- This $ 9.5 m will go in the P&L as depreciation expense for the year
- This $ 9.5 m will get added in the accumulated depreciation till last year($ 1 m) and accumulated depreciation for 2006 becomes $ 10.5 million
This is how asset scheduled is built and linked with P&L and Balance sheet