May 3, 2011
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.
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:
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.
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 is how asset scheduled is built and linked with P&L and Balance sheet