Methods of Recording Depreciation in Financial Accounts

When a business buys machinery, furniture, or a vehicle, that asset does not stay worth its purchase price forever. Wear and tear, usage, and time reduce its value every year, and accounting rules require this reduction to be recorded formally as depreciation. But here is the part most students miss: there are two distinct ways to record this reduction in the books, and choosing between them changes how your balance sheet looks, even though the underlying economics stay the same. Let’s break down both methods, when each one is used, and why the choice matters for accurate financial reporting.

Why the method of recording depreciation matters 🔗

Depreciation exists to apply the matching principle, the idea that expenses should be recorded in the same period as the revenue they help generate. If a company buys a delivery van for ₹5,00,000 and uses it for five years, charging the entire cost as an expense in year one would distort profits badly. Spreading that cost across five years gives a truer picture of how much the van actually cost the business each year.

What changes between the two recording methods is not the amount of depreciation, but where it gets recorded and how the asset account and the balance sheet end up looking. One method keeps the original cost untouched and tracks depreciation separately. The other reduces the asset’s value directly in its own account. Both are accepted accounting practices, and understanding the mechanics of each is a core skill for any commerce student.

Method 1: Maintaining a provision for depreciation account 🔗

This approach, also called the indirect method, uses a separate ledger account called the Provision for Depreciation Account (sometimes called the Accumulated Depreciation Account). Instead of reducing the asset account every year, all depreciation charges accumulate in this separate account. This lets the company’s financial statements reflect the current value of its fixed assets while preserving the historical cost record.

How the journal entries work 🔗

Under this method, two entries are typically passed each year:

Notice that the Asset Account is never touched in these entries. It continues to show the original purchase price, untouched, year after year.

A working example 🔗

Suppose a company buys machinery for ₹1,00,000 with an expected useful life of 10 years and no scrap value, using the straight-line method. Annual depreciation works out to ₹10,000. Over three years, the Provision for Depreciation Account would show an accumulated balance of ₹30,000, while the Machinery Account would still read ₹1,00,000 on its own. The net book value at that point, calculated separately, is ₹70,000.

How it appears in the balance sheet 🔗

On the balance sheet, the asset is shown at its original cost, with accumulated depreciation deducted either right below it or shown separately on the liabilities side as a contra account. Because Provision for Depreciation is a contra asset account, it works against the asset’s balance to arrive at the carrying value without altering the original figure.

This structure has a practical advantage: anyone reviewing the accounts can immediately see both the original investment in the asset and how much of it has been used up, without digging through old records.

Method 2: Charging depreciation directly to the asset account 🔗

The second approach, known as the direct method, skips the separate provision account entirely. Depreciation is debited to the Depreciation Account and credited straight to the specific Asset Account, reducing its book value with each entry.

Journal entries 🔗

Example using the same figures 🔗

Using the same machinery example, ₹10,000 is credited directly to the Machinery Account each year. After three years, the Machinery Account itself would show a balance of ₹70,000, not ₹1,00,000. There is no separate record showing that ₹30,000 has been depreciated unless you check old ledger entries or notes to accounts.

Balance sheet presentation 🔗

Under this method, the asset appears on the balance sheet at its written down value directly, with no accompanying figure for original cost or accumulated depreciation. This is simpler to prepare but gives the reader less information at a glance.

Provision method vs direct method: a quick comparison 🔗

Which method should you use? 🔗

In practice, the provision for depreciation method is more commonly used by businesses, and for good reason. Keeping the asset at historical cost while tracking accumulated depreciation separately makes financial statements more transparent. Investors, auditors, and management can immediately compare how much of an asset’s useful life has been consumed relative to its original investment, which is useful for planning replacements and understanding capital efficiency.

There is also a regulatory angle worth knowing. Depreciation accounting in India is shaped by the Companies Act, 2013, particularly Schedule II, which moved companies from fixed depreciation rates to a useful-life based approach for computing depreciation. While the Act does not mandate which of the two recording methods to use, the practical need to disclose useful life, residual value, and the depreciation charge for each class of asset makes the provision account approach far more convenient for compliance and disclosure purposes.

Chartered Accountancy and company law literature built around the Institute of Chartered Accountants of India’s guidance on depreciation under Schedule II also leans on the useful life and accumulated depreciation concept, reinforcing why the indirect method aligns better with how Indian companies are expected to report and justify their depreciation policies.

That said, the direct method is not wrong, it is simply less informative. Small businesses or sole proprietorships with only a handful of assets and no strong need for detailed disclosure may find charging depreciation straight to the asset account faster and easier to maintain, since it avoids the overhead of running a separate account for every asset class.

A note on asset disposal 🔗

The choice of method also affects how you record the sale or disposal of an asset. Under the provision method, you typically open an Asset Disposal Account, transfer both the original cost and the accumulated depreciation into it, and then work out the profit or loss on sale. Under the direct method, since the asset account already reflects the written down value, the calculation is more straightforward but relies on the assumption that all prior depreciation entries were accurate and complete, since there’s no separate audit trail to cross-check against.

Bringing it together 🔗

Both methods achieve the same underlying goal: allocating the cost of an asset systematically over its useful life so that profit figures remain realistic and the balance sheet reflects genuine asset values. The provision for depreciation account method offers better transparency and is generally the preferred choice for organisations that need clear, auditable records. The direct method trades some of that visibility for simplicity, which can suit smaller setups with limited reporting needs.

As you work through numerical problems in your textbook, pay close attention to which method a question specifies. Getting the journal entries and balance sheet treatment right depends entirely on correctly identifying whether a provision account is being maintained or not.

What do you think? If you were setting up the books for a small trading business with just two or three fixed assets, would you lean toward the simplicity of the direct method, or would you still maintain a provision account for the sake of transparency? And how might your answer change if that business were preparing to seek a bank loan?

References

1. https://www.geeksforgeeks.org/accountancy/provision-for-depreciation-and-asset-disposal-account/
2. https://www.accountingcapital.com/differences/difference-between-depreciation-and-provision-for-depreciation/
3. https://www.accountingcapital.com/journal-entries/journal-entry-for-depreciation/
4. https://www.india-briefing.com/news/depreciation-asset-management-under-indian-gaap-40359.html/
5. https://resource.cdn.icai.org/41241research31047.pdf