Accumulated Depreciation – Explanation and Guide

What Is Accumulated Depreciation?

Accumulated DepreciationAccumulated depreciation is the total amount of depreciation expense written off against an asset from the time it was put into service. Put another way, it is the cumulative value of an asset up to a single point in its expected life as it is used up. Accumulated depreciation is a contra asset account.  This means its natural place on the balance sheet is a credit.  It reduces the overall asset value which is recorded as a debit.

Unlike a normal asset account, a credit to a contra-asset account increases its value while a debit decreases its value. Whenever depreciation expense is recorded for an organization, the same amount is also credited to the accumulated depreciation account.  This allows the company to show both the cost of the asset and the total depreciation of the asset. It also records the asset’s net book value on the balance sheet.

Depreciation is recorded to capture the cost of using a long-term capital asset with the benefit gained from its use over time.  Accumulated depreciation is the sum of all recorded depreciation on an asset to a specific date. Accumulated depreciation is listed on the balance sheet just below the related capital asset line.  The carrying value of an asset is its historical cost minus accumulated depreciation.

Accumulated Depreciation – A Deeper Look

There is a  matching principle under generally accepted accounting principles (GAAP).  It requires expenses to be matched to the same accounting period in which the related revenue is generated. Through depreciation, a business will expense a portion of a capital asset’s value over each year of its useful life. As a result, for each year a capitalized asset is put to use and generates revenue, the cost associated with using up the asset must also be recorded.

What Is Depreciation Expense? 

Depreciation expense is the allocated portion of the cost written off against a company’s fixed assets. Depreciation expense is recorded on the income statement as a non-cash expense that reduces the company’s net income. For accounting purposes, the depreciation expense is debited, and the accumulated depreciation is credited.  It is considered a non-cash expense.  This is because the recurring monthly depreciation entry does not involve a cash transaction. As a result, the statement of cash flows prepared under the indirect method adds the depreciation expense back to calculate cash flow from operations.  Common depreciation methods can include straight line, double-declining balance, and units of production.

Is Accumulated Depreciation an Asset?

Accumulated depreciation is known as a contra asset account. Contra asset accounts are negative asset accounts.  They are designed to offset the balance of the asset account as the asset is used up. In a standard asset account, credits decrease the value while debits to the account increase its value. A Contra asset works exactly the opposite.  Credits increase its value while debits decrease its value.

Accumulated depreciation is typically shown in the Fixed Assets or Property, Plant & Equipment section of the balance sheet.  It is a contra asset account of the company’s fixed assets. Showing contra accounts such as accumulated depreciation on the balance sheets gives the users of financial statements more information about the company.  Otherwise, the users would not know the asset’s cost or the amount of depreciation attributed to each class of asset.

Separately stating depreciation on the balance sheet provides valuable information. Anyone reading the financial statement can quickly know what the asset originally cost.  Next, they can see how much has been written off. Finally, it can help them estimate the asset’s remaining useful life. Accumulated depreciation is not a current asset.  Current assets aren’t depreciated because they aren’t expected to last longer than one year.

How to Calculate Accumulated Depreciation

Most businesses calculate depreciation and record monthly journal entries for depreciation. The actual calculation depends on the depreciation method you use. Two of the most popular depreciation methods are straight-line and MACRS.

Straight-line depreciation

Using the straight-line method, you depreciation property at an equal amount over each year in the life of the asset.  Using this method, you choose to depreciate your property at an equal amount for each year over its useful lifespan.  Use the following steps to calculate monthly straight-line depreciation:

  • Subtract the asset’s salvage value from its cost to determine the amount that can be depreciated
  • Divide this amount by the number of years in the asset’s useful lifespan
  • Divide by 12 to tell you the monthly depreciation for the asset

For example, say your company has a vehicle and the cost of this asset is $60,000. You expect the vehicle to be worth $10,000 at the end of five years.  You plan to replace it then.  If you depreciate the vehicle over five years, you will record $10,000 of accumulated depreciation per year, or $833.33 per month.

First, subtract the salvage value ($10,000) from the cost ($60,000), which leaves $50,000.  Next, divide this amount by the useful lifespan – $50,000/ 5 years.  Accumulated depreciation is $10,000/year, or $833.33/month.

MACRS Depreciation

For tax purposes, the IRS requires businesses to depreciate most assets using the Modified Accelerated Cost Recovery System (MACRS).  Under MACRS, the IRS assigns a useful life to different types of assets. For example, office furniture is depreciated over seven years, automobiles get depreciated over five years, and commercial real estate is depreciated over 39 years. MACRS depreciation is an accelerated method of depreciation.  It allows businesses to take a higher depreciation amount in the first year an asset is placed in service.  After the first year, MARCS allows less depreciation each subsequent year.

To calculate depreciation using MACRS, you first determine the asset’s classification, i.e., three-year property, five-year property, etc. Then you use the tables found in IRS Publication 946 to calculate depreciation for that year.

Example of Accumulated Depreciation 

Straight-line depreciation expense is calculated by finding the depreciable base of the asset.  This equals the difference between the historical cost of the asset and its salvage value. The depreciable base is then divided by the asset’s useful life in order to get the periodic depreciation expense. In this example, the historical cost of the asset is the purchase price.  The salvage value is the value of the asset at the end of its useful life.  This is also referred to as scrap value.  The useful life is the number of years the asset is expected to provide value.

Company A buys a piece of equipment with a useful life of 10 years for $110,000. The equipment is estimated to have a salvage value of $10,000. The equipment is going to provide the company with value for the next 10 years, so the company expenses the cost of the equipment over the next 10 years. Straight-line depreciation is calculated as (($110,000 – $10,000) / 10), or $10,000 a year. This means the company will depreciate $10,000 for the next 10 years until the book value of the asset is $10,000.  Each year the contra asset account referred to as accumulated depreciation increases by $10,000. For example, at the end of five years, the annual depreciation expense is still $10,000, but accumulated depreciation has grown to $50,000. That is, accumulated depreciation is a cumulative account. It is credited each year as the value of the asset is written off and remains on the books, reducing the net value of the asset, until the asset is disposed of or sold. It is important to note that accumulated depreciation cannot be more than the asset’s historical cost even if the asset is still in use after its estimated useful life. (Source:investopedia)

Accumulated Depreciation and Book Value 

Accumulated depreciation is used in calculating an asset’s net book value. This is the amount a company carries an asset on its balance sheet. Net book value is the cost of an asset minus its accumulated depreciation. For example, a company purchases a piece of packing equipment for $200,000 and the accumulated depreciation is $50,000.  Then the net book value of the packing equipment is $150,000.  Accumulated depreciation cannot exceed an asset’s cost. If an asset is sold or disposed of, the asset’s accumulated depreciation is removed from the balance sheet. Net book value, however, isn’t necessarily reflective of the market value of an asset.

Up Next: Series24 – What Is the Series 24 Exam?

Series24 licensing is required for general securities principals to manage or supervise investment banking or securities business activities.  The Series 24 is an exam and license entitling the holder to supervise and manage branch activities at a broker-dealer. It is also known as the General Securities Principal Qualification Examination.  It was designed to test the knowledge and competency of candidates aiming to become entry-level securities principals. Supervisory activities allowed after passing the exam include regulatory compliance over trading and market-making activities, underwriting, and advertising.

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