 Depreciation is an example of a deferral adjusting entry. It occurs when cash is paid to acquire long lived assets before depreciation expense is incurred. Let's look at this example. Assume on January 1, Morrissey purchases a tour bus for $200,000. Let's answer the following questions. What is the journal entry on January 1? Is this an adjusting entry? And what are the balances on the unadjusted trial balance for equipment, depreciation expense, and accumulated depreciation? The journal entry on January 1 is a debit to the asset account equipment and a credit to the asset account cash for $200,000. This is not an adjusting entry because there is an underlying transaction that happened on January 1. Let's learn how to depreciate this bus using the simplest method and then record that in an adjusting entry. The most common method of depreciation is known as the straight line method. This method just spreads the cost of a long lived asset evenly over the asset's useful life. The formula is asset cost minus residual value or sometimes called salvage value divided by the useful life in years. In our example, assume that on January 1, Morrissey purchases a tour bus for $200,000 and the bus will have a 10 year useful life and no residual value. That works out to be $20,000 of depreciation expense each year for 10 years. So let's make the adjusting entry. Following the same pattern as our other deferral adjusting journal entries, we might assume that it is something like what I've shown here, a debit to depreciation expense and a credit to equipment for $20,000. But that is not correct for tangible assets with long lives. A long-term tangible asset like equipment still physically exists after it's been fully depreciated. This is different than say supplies, which do not exist once they've been fully used up. Thus, we cannot credit the equipment account until that balance is zero. We need to use a new account called accumulated depreciation. This account's purpose is exactly what the name describes. It is the accumulation of all of the year's depreciation expense. Accumulated depreciation is a contra asset account. This means that it is an asset, but it has a normal credit balance rather than a debit balance like all of our other asset accounts. This won't be the only contra account you learn. So let's define what makes an account contra. A contra account must meet two criteria. The first is that it must have a companion account. In this example, the companion account is equipment. For example, if we never owned any equipment, we would never have an account called accumulated depreciation for equipment. The second is that it has a normal balance opposite its companion account. Since equipment has a normal debit balance, accumulated depreciation must have a credit balance. Finally, let's look at the balance sheet presentation for equipment. Notice here that accumulated depreciation is deducted from the equipment cost to arrive at a net amount. We call that net book value. It's important, you might wanna write it down. The calculation is cost minus accumulated depreciation equals net book value.