The accumulated depreciation is the total amount of depreciation expense allocated to a specific asset since it was started using. It is an asset account, but negative, which amortizes the balance of the asset account with which it is associated. This would be an account called as counter-assets.
Accumulated depreciation is associated with built assets, such as buildings, machinery, office equipment, furniture, accessories, vehicles, etc.
The original cost of the asset is known as its gross cost, while the original cost of the asset less the amount of accumulated depreciation is known as its net cost or book value.
Therefore, the book value of an asset, on the balance sheet, is the difference between its purchase price and accumulated depreciation.
Accumulated depreciation is the total depreciation of a fixed asset, which has been charged to expenses since the asset was acquired and made available for use.
The amount of accumulated depreciation of an asset will increase over time as the depreciation continues to be charged against the asset.
The accumulated depreciation account is an asset account with a credit balance, also known as a counter-asset account.
This means it appears on the balance sheet as a reduction in the gross amount of reported fixed assets. It is credited when the depreciation expense is recorded in each accounting period.
What is accumulated depreciation?
Capitalized assets are those that provide value for more than one year, and accounting rules dictate that both expenses and sales are recorded in the period in which they are incurred.
As a solution to this recording problem for capitalized assets, accountants use a process called depreciation.
Accumulated depreciation is relevant for capitalized assets. The other type of asset is the operating one, which is spent the same year it was purchased, since it is generally sold or used within the year of its purchase.
Depreciation expends a portion of the cost of the asset in the year it is purchased and for the remainder of the asset’s life. Accumulated depreciation represents the total amount that the asset has depreciated over the useful life of the asset.
When a depreciation expense is recorded for an organization, the same amount is also credited to the accumulated depreciation account, allowing the company to display both the cost of the asset and the total depreciation of the asset. This also shows the net book value of the asset on the balance sheet.
The amount of accumulated depreciation is used to determine the carrying amount of a fixed asset. For example, a delivery truck with a cost of $ 50,000 and accumulated depreciation of $ 31,000 will have a book value of $ 19,000.
Financial analysts will create a depreciation schedule when modeling financials to track total depreciation over the life of an asset.
Unlike a normal asset account, a credit to a counter-asset account increases in value. On the other hand, a debit decreases its value.
A company purchases and holds an asset on the balance sheet until its carrying amount matches its salvage value.
The accumulated depreciation of each fixed asset cannot exceed the cost of the asset. If an asset remains in use after its cost has fully depreciated, the cost of the asset and its accumulated depreciation will remain in the general ledger accounts and depreciation expense will stop.
When the asset is finally retired, the amount in the accumulated depreciation account related to that asset is reversed. It is also done with the original cost of the asset, thus eliminating any record of the asset from the company’s balance sheet.
If this decline were not finalized, a company would gradually accumulate a large amount of gross costs and accumulated depreciation of fixed assets on its balance sheet.
Market value of assets
It is important to note that the book value of an asset does not indicate the market value of the asset. This is because depreciation is simply an allocation technique.
When a company’s accumulated depreciation is high, its net book value may be below the company’s true market value, which means that the company could be overvalued.
Likewise, if the business’s accumulated depreciation is low, its net book value may be above the true market value and the business may be undervalued.
The disparity highlights a very important aspect of accumulated depreciation: it does not reflect true losses in the market value of an asset (or a company).
How is it calculated?
Over time, the assets a business owns lose value, known as depreciation. As the value of these assets decreases over time, the depreciated amount is recorded as an expense on the balance sheet.
The determination of the monthly accumulated depreciation of an asset depends on the useful life of the asset. It also depends on the accounting method you choose to use.
Straight line method
With the straight-line method, you choose to depreciate the asset an equal amount for each year during its useful life. Here are the steps to calculate monthly linear depreciation:
First, the asset’s recoverable value is subtracted from its cost to determine the amount that can be depreciated:
Total depreciation = Cost of the asset – Recovery value.
Next, this amount obtained is divided by the number of years of useful life of the asset:
Annual depreciation = Total depreciation / Useful life of the asset.
Finally, dividing this amount by 12 will obtain the monthly depreciation of the asset:
Monthly depreciation = Annual depreciation / 12.
Calculation of accumulated depreciation
Calculating accumulated depreciation is a simple matter of running the depreciation calculation for a fixed asset from its acquisition date to its disposal date.
However, it is useful to do a random check of the calculation of the depreciation amounts that were posted to the general ledger over the life of the asset, to ensure that the same calculation was used to post the underlying depreciation transaction.
For example, ABC International buys a machine for $ 100,000, which it records in the fixed assets account of Machinery.
ABC estimates that the machine has a useful life of 10 years and will have no salvage value. For this reason, you will charge $ 10,000 in depreciation expense per year for 10 years. The annual entry, showing the credit to the accumulated depreciation account, is:
After 10 years, ABC retires the machine and records the following entry to remove both the asset and its associated accumulated depreciation from its accounting records:
Accumulated depreciation is a key component of the balance sheet and is a key component of net book value. Net book value is the value at which a company carries an asset on its balance sheet. It is equal to the cost of the asset less accumulated depreciation.
The straight-line depreciation expense is calculated by dividing the difference between the cost of the asset and its recoverable value, by the useful life of the asset.
In this example, the cost of the asset is the purchase price. The salvage value is the value of the asset at the end of its useful life, also called scrap value. The useful life is the number of years the asset is expected to provide value.
Company A purchases a piece of equipment with a useful life of 10 years, for $ 110,000. The equipment has a salvage value of $ 10,000 at the end of its useful life.
The team will provide value to the company for the next 10 years. In this sense, analysts will have to spend the cost of the equipment in the next 10 years.
Straight-line depreciation is calculated as $ 110,000 minus $ 10,000, divided by 10 years, or $ 10,000 per year. This means that the company will depreciate $ 10,000 over the next 10 years, until the asset’s book value is $ 10,000.
Each year, the account against the asset, called accumulated depreciation, increases by $ 10,000. For example, at the end of five years, the annual depreciation expense will still be $ 10,000, but the accumulated depreciation will have increased to $ 50,000.
Accumulated depreciation is a cumulative account. It is credited each year, as the value of the asset is amortized. It remains on the ledgers until the asset is sold.
It is important to note that the accumulated depreciation cannot be greater than the cost of the asset. This is even if the asset is still used after its accounting useful life.
Suppose company XYZ bought a machine for $ 100,000 three years ago. The machine depreciates by $ 10,000 a year. Thus, the accumulated depreciation recorded for the machine is:
Accumulated depreciation = $ 10,000 (year 1 depreciation) + $ 10,000 (year 2 depreciation) + $ 10,000 (year 3 depreciation) = $ 30,000.
Company XYZ will then record the net book value of the machine as follows:
Net book value = $ 100,000 purchase price – $ 30,000 accumulated depreciation = $ 70,000.
- Investopedia (2018). Accumulated Depreciation. Taken from: investopedia.com.
- Harold Averkamp (2018). What is accumulated depreciation? Accounting Coach. Taken from: accountingcoach.com.
- Steven Bragg (2017). Accumulated depreciation. Accounting Tools. Taken from: accountingtools.com.
- Investing Answers (2018). Accumulated Depreciation. Taken from: investinganswers.com.
- CFI (2018). What is Accumulated Depreciation? Taken from: corporatefinanceinstitute.com.
- The Motley Fool (2018). How to Calculate Monthly Accumulated Depreciation. Taken from: fool.com.