Accumulated Depreciation

What is Accumulated Depreciation?

Definition: Accumulated depreciation is the total sum of depreciation expense recorded for an asset.

A lot of people confuse depreciation expense with actually expensing an asset. This isn’t the case, however. Fixed assets are capitalized when they are purchased and reported on the balance sheet. No costs are initially recorded on the purchase date. Instead, the asset’s costs are recognized ratably over the course of its useful life with depreciation. This cost allocation method agrees with the matching principle since costs are recognized in the time period that the help produce revenues.

Accumulated depreciation is the total amount of a plant asset’s cost that has been allocated to depreciation expense (or to manufacturing overhead) since the asset was put into service. Accumulated depreciation (and the related depreciation expense) are associated with constructed assets such as buildings, machinery, office equipment, furniture, fixtures, vehicles, etc.

Accumulated depreciation is also the title of the contra asset account. Accumulated depreciation is credited when depreciation expense is debited each accounting period.

Subtracting accumulated depreciation from an asset’s cost results in the asset’s book value or carrying value. Hence, the credit balance in the account accumulated depreciation cannot exceed the debit balance in the related asset account.

What Does Accumulated Depreciation Mean?

The accumulated depreciation account is a contra asset account that lowers the book value of the assets reported on the balance sheet. Fixed assets are always listed at their historical cost followed by the accumulated depreciation. The accumulated depreciation can be subtracted from the historical cost to arrive at the current book value. This presentation allows investors and creditors to easily see the relative age and value of the fixed assets on the books. It also gives them an idea of the amount of depreciation costs the company will recognize in the future.

The matching principle under generally accepted accounting principles (GAAP) dictates that expenses must 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. This means that each year a capitalized asset is put to use and generates revenue, the cost associated with using up the asset is recorded.

Accumulated depreciation is the total amount an asset has been depreciated up until a single point. Each period, the depreciation expense recorded in that period is added to the beginning accumulated depreciation balance. An asset’s carrying value on the balance sheet is the difference between its historical cost and accumulated depreciation. At the end of an asset’s useful life, its carrying value on the balance sheet will match its salvage value.

When recording depreciation in the general ledger, a company debits depreciation expense and credits accumulated depreciation. Depreciation expense flows through to the income statement in the period it is recorded. Accumulated depreciation is presented on the balance sheet below the line for related capitalized assets. The accumulated depreciation balance increases over time, adding the amount of depreciation expense recorded in the current period.

Example

Assume that a company purchased a delivery vehicle for $50,000 and determined that the depreciation expense should be $9,000 for 5 years. Each year the account Accumulated Depreciation will be credited for $9,000. Since this is a balance sheet account, its balance keeps accumulating. Therefore, after three years the balance in Accumulated Depreciation will be a credit balance of $27,000 and the vehicle’s book value will be $23,000 ($50,000 minus $27,000).

It is important to note that an asset’s book value does not indicate the vehicle’s market value since depreciation is merely an allocation technique.

If the vehicle is sold, both the vehicle’s cost and its accumulated depreciation at the date of the sale will be removed from the accounts. If the amount received is greater than the book value, a gain will be recorded. If the amount received is less than the book value, a loss is recorded.

Debiting Accumulated Depreciation

In most scenarios, we credit the accumulated depreciation account because, as time passes, the company records the depreciation expense that is accumulated in the contra-asset account. However, there are situations when the accumulated depreciation account is debited or decreased. For example, let’s say an asset has been used for 5 years and has an accumulated depreciation of $100,000 in total. After the 5-year period, if the company were to sell the asset, the account would need to be zeroed out because the asset is not relevant to the company anymore. Therefore, there would be a credit to the asset account, a debit to the accumulated depreciation account, and a gain or loss depending on the fair value of the asset and the amount received.

Summary

  • Depreciation is recorded to tie 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 presented on the balance sheet just below the related capital asset line.
  • The carrying value of an asset is its historical cost minus accumulated depreciation.

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