What is Accumulated depreciation?

Accumulated depreciation is an example of the total depreciation for a fixed asset that has been charged for the expenses since that asset was acquired and was made available for use. 

The accumulated depreciation account is also an asset account with a credit balance known as a contra asset account.  It means that it appears on the balance sheet as a deduction from the gross amount of fixed assets as it is reported.

There will increase the amount of accumulated depreciation for an asset over time as a depreciation keeps continuing to be charged against the asset.  The original cost of the asset is also known as its gross cost. In contrast, the asset’s original cost will be less than the amount of accumulated depreciation, and any impairment is also known as its net cost or even carrying the amount.

There will be an increase in the balance in the accumulated depreciation account more quickly if a business uses an accelerated depreciation methodology since it charges more of an asset’s cost to expenses used during its earlier years. 

Eventually, when the asset is retired or sold, the amount in the accumulated depreciation account would be related to that asset, which is reversed, as is the asset’s original cost, thereby eliminating all the assets from the company’s balance sheet. 

If this DE recognition were in completed, a company would gradually build up a huge amount of gross fixed asset cost and accumulate the depreciation on its balance sheet. Calculation of accumulated depreciation is a simple matter of running depreciation for a fixed asset from its acquisition date to its disposition date. 

However, it is very useful to spot-check the calculation of the depreciation amounts recorded in the general ledger over the asset’s life to ensure that the same calculations were used to record the underlying depreciation transaction.

Understanding Accumulated Depreciation-

Generally, under the matching principle, accepted accounting principles dictate that must match expenses to the same accounting period in which it is generated as the related revenue. A business will expense a part of its capital asset’s value over each year of its useful life through depreciation. 

It means that every year, a capitalized asset has been put to use, and it generates revenue; this is the cost associated with using up the asset record. Accumulated depreciation is the total amount in which an asset has been depreciated up to a single point. 

Each time, the depreciated expenses are recorded in that period and added to the beginning accumulated depreciation balance.  An asset’s carrying value in the balance sheet is the difference between its old cost and the accumulated depreciation. At the last of an asset’s useful life, the balance sheet’s carrying value will match its salvage value.

While recording depreciation in the general ledger, a company’s debit depreciation expenses and credits accumulated depreciation.  Depreciation expenses are flowed through to the income statement in the period, and it is recorded. It is represented below the balance sheet the line for related capitalized assets. 

The accumulated depreciation balance increases over time, adding the depreciation expense recorded in the current period. 

What are depreciation expenses?

On the other hand, depreciation expenses are the specified portion of the cost of a company’s fixed assets required for the period.  Depreciation expense is properly recognized on the income statement as a non-cash expense that has been reduced the company’s net income. 

For accounting purposes, the depreciation expenses can be debited, and the accumulated depreciation can be credited. It can be considered a non-cash expense because the recurring monthly depreciation entry is not involved in a cash transaction. 

This statement of cash flows is prepared under the indirect method, and there is a depreciation expense that calculates cash flow from operations. Typical depreciation methods can include straight lines, double-declining balance, and units of production.

Is accumulation depreciation an asset?

Accumulated depreciation is a kind of total depreciation for a fixed asset assigned as an expense as the asset obtained and made available for use.  It is an asset account with a credit balance which is known as a contra asset account. It is displayed in the balance sheet as a deduction from the gross amount of fixed assets as reported.

The depreciation expense account is debited each year by expending a portion of the asset for that particular year. The accumulated depreciation account is also credited from the same amount.  Accumulated depreciation also increases over the years as depreciated expenses are charged against the value of fixed assets.

When an asset is sold or retired, there is a reversion of the total associated amount of the asset by completely removing the record of the asset from a business’ financial books. 

How to calculate monthly accumulated depreciation?

Depreciation can be calculated monthly, and there are two methods which are mentioned below:

As it is determined on a monthly accumulated depreciation for an asset, it depends on the asset’s most useful lifespan as it is defined by the internal revenue service and which accounting method you use.

The useful lifespan can be ranging from 3 to 20 years for personal property; for land improvements, it can be 15 to 20 years and are fixed for residential real estate at 27.5 years and 39 years for business real estate. The internal revenue service has information about the depreciation and its assets lifespan.

The internal revenue services are currently using the Modified Accelerated Cost Recovery depreciation system, which allows the depreciation to be calculated using the straight-line method or the declining balance method.

Straight line depreciation

For performing the straight-line method, you have to choose to depreciate your property at an equal amount each year over its useful lifespan. By using the following steps, you can calculate monthly straight-line depreciation:

Determine the amount that can be depreciated by subtracting the asset’s salvage value from its cost.  Then divide this amount by the count of years in the asset’s useful lifespan.  Then divide it by 12 to tell you the monthly depreciation for the asset.

Declining Balance Method

The declining balance method is used for recognizing the majority of an asset’s depreciation at early of its lifespan. 

There are also two variations of this: 

1. The double-declining balance method.

2. The 150% declining balance method.

Depreciation amount changes from one year to another year using either of these methods, so it becomes more complicated for calculating the straight-line method.

For the double-declining balance method, the following formula is used to calculate each year’s depreciation amount: To convert this from annual to monthly depreciation, divide this result by 12.

Recording accumulated depreciation in books

While reporting depreciation, in the general ledger, a company debits the depreciation account and the cumulative depreciation account is credited.  Depreciation expenses will also pass through the income statement of a specified period when it passed the above entry.

Accumulated depreciation for the related capitalized assets is shown on the balance sheet below the line.  The accumulated balance of depreciation increases over time, adding the depreciation expense recorded during the current period. 

Accumulated depreciation on long term assets

Some assets are considered as short-term, which is used up within a year, like office supplies. Long-term assets are also used for over several years, so the cost is spread out over those years. Short-term assets are also put into your business balance sheet, but they are not depreciated.

Long-term assets are depreciated like buildings, machinery, equipment, furniture and fixtures, and vehicles. The internal revenue system calls these capital assets tangible and generally illiquid, which cannot easily turn into cash and property used by a business to generate profit. The usefulness of capital assets can be expected to be greater than a year. 

Accumulated depreciation can be the total decrease in the value of an asset and the balance sheet of a business over time. The cost for each year you owning the asset becomes a business expense for that particular year. This expense is tax-deductible so that it can reduce your taxable business income for the year. 

Two more terms related to long-term assets:

Residual value

Most capital assets except land have a residual value; sometimes, it is called “a scrap value” or even “a salvage value.” This value is the asset worth the end of its useful life and what could sell it.

Book value

The book value of the asset on your business balance sheet can be at any one time, called its book value. The original cost is subtracted from the accumulated depreciation. Book value may be but not necessarily related to the asset’s price if you are selling it. Then it depends on whether the asset has residual value.

Accumulated depreciation and your business taxes

You would not see “Accumulated Depreciation” on a business tax form. Still, depreciation is included, as noted above, as it is an expense on the business profit and loss report. 

The good news is that the depreciation can be considered a “non-cash” expense. You can also count it as an expense for reducing the income tax as your business must pay, but you do not have to spend any money for getting this deduction. 

What is seeing in your business tax form is the number of depreciation expenses taken for the year, including all types of depreciation on all business property.  

E.g., as it is said on Schedule C for a sole proprietor business, Line 13 under Expenses that “Depreciation and Section 179 deductions….” at that point where you see the total of all the depreciation which are taken during the year.

You must complete internal revenue service form 4562 Depreciation and Amortization for property under some circumstances:

If Section 179 is taken for deducing from the current year or a Section 179 to carryover deduction from a prior year.

If you are placing the property in service, bought and started using it during the current year.

If the depreciation expenses are claimed on a vehicle or listed property, it will be placed in service regardless. 

Business vs Personal Use depreciation 

If you are using an asset like a car for business or personal travel, you can not depreciate the car’s entire value. Still, you can only depreciate the percentage of use that is for business. 

E.g., if you are using your car 60% of the time for business and 40% for personal, you can only depreciate 60%. 10 

Legally, you can also accelerate depreciation by getting more of the tax benefit by the first year you are owning the property and put it into service. 

The extra amounts of depreciation include the bonus depreciation and deductions according to Section 179. It can change the amounts every year, so always have a check with your tax preparer.

Net accumulated depreciation

When you are looking at the balance sheet, you probably can’t see the individual assets but rather the consolidated assets like a total of all office equipment, computers, furniture, fixtures, lamps, planes, trucks, railroad cars, buildings, land, and more. 

Many businesses do not even bother to show that you have the accumulated depreciation account at all. 

Instead, they can only show a single line called “Property, Plant, and Equipment Net.” That “net” addendum refers to the fact that the company is deducting accumulated depreciation from the purchasing price of the company’s assets and is also shows you only the bottom line result. 

Once the asset has become worthless or sold, both it and the matching accumulated depreciation account have to be removed from the balance sheet. 

Any gain or loss from above the book value, or carrying value, have been recorded according to the specific accounting rules, which depends on the situation.

Example of Accumulated depreciation:

Calculating the Straight-line depreciation expense can be found by the asset’s depreciable base, which is also equal to the difference between the asset’s historical costs and salvage value.  The depreciable base is also then divided by the asset’s useful life for getting the periodic depreciation expenses. 

If we see an example, then the historical cost of the asset is also the purchase price, the value of salvage is the value of the asset which is at the end of its useful life, and also referred to as scrap value, and it is also useful life in the number of years in which the asset is expected to provide value.

Company A purchases a piece of equipment with a useful life of 10 years for around $110,000. This equipment is estimated to have a salvage value of $10,000.  The equipment will provide the company with value for the next ten years, so the company’s expenses are the cost of the equipment over the next ten years. 

Straight-line depreciation is also calculated as ($110,000 – $10,000) / 10), or $10,000 a year. It means the company will depreciate $10,000 for the next ten years until the asset’s book value reaches $10,000.

Every year the contra asset account is referred to as accumulated depreciation which is increased by $10,000. 

E.g., at the end of five years, the annual depreciation expense is still $10,000, but accumulated depreciation has grown up to $50,000. 

That is, accumulated depreciation is also a cumulative account. It is also credited each year as the asset’s value is written off and remains on the books, reducing the asset’s net value until the asset is disposed of or even considered as sold. 

It is also important to note that accumulated depreciation cannot be more than the assets historical cost even if it is still in use after its estimated useful life.

Frequently Asked Questions:

What is accumulated depreciation?

Accumulated depreciation is a kind of cumulative depreciation of an asset that is up to a single point in its life. Accumulated depreciation is also a contra asset account, which means its natural balance reduces the overall asset value.

How to calculate accumulated depreciation?

Calculating the accumulated depreciation is by subtracting the estimated scrap or salvage value at the end of its life, which is useful from the initial cost of its asset. And then it will be divided it by the number of the estimated life which is useful of an asset.

Formula for calculating the accumulated depreciation:

Accumulated Depreciation = ((Cost of Assets – Salvage Value)/ Life of the Assets)* No of years

Cost of Assets : Acquisition Cost of Assets

Salvage Value also known as Residual Value = Value of Assets after completion of life cycle.

Life of Assets = This is a number of year or month the assets can be use.

Why is accumulated depreciation an asset?

A cumulative depreciation is known as the accumulated depreciation of an asset that has been recorded.  Property, plant and equipment, which are counted under fixed assets, are considered as long-term assets. 

Depreciation expenses a portion of the asset’s cost in the year purchased each year for the rest of the assets useful throughout the life.  Accumulated depreciation also allows investors and analysts to see how much of a fixed asset‘s cost has been depreciated.