What is accumulated depreciation
Accumulated depreciation is the running total of depreciation expense recorded against a long‑lived tangible asset since it was placed in service. Depreciation expense is the allocation of an asset’s cost over its useful life. Accumulated depreciation is a contra‑asset account—its balance reduces the carrying (book) value of the related fixed asset on the balance sheet.
Why it matters
– Shows how much of an asset’s cost has been expensed to date.
– Helps users assess an asset’s net book value (cost less accumulated depreciation).
– Affects expense recognition, reported profits, and balance‑sheet metrics.
Key terms (defined on first use)
– Depreciation expense: the periodic charge to profit and loss that allocates part of an asset’s cost to a reporting period.
– Contra‑asset account: a balance‑sheet account with a credit balance that offsets a related asset account.
– Salvage (residual) value: the estimated proceeds from disposing of the asset at the end of its useful life.
– Useful life: management’s estimate of the period an asset will generate economic benefits.
Where it appears in the financial statements
Accumulated depreciation is shown on the balance sheet directly beneath the related property, plant, and equipment (PP&E) line. Net book value = Historical cost − Accumulated depreciation.
Common methods to calculate depreciation (and how accumulated depreciation is built)
1) Straight‑line method
– Formula: Annual depreciation = (Cost − Salvage value) / Useful life (years).
– Pattern: Equal charge each year.
– Example: Cost $250,000, salvage $10,000, life 20 years → (250,000 − 10,000) / 20 = $12,000 per year. After 5 years, accumulated depreciation = $60,000.
2) Declining balance method
– Formula (general): Depreciation for year t = Rate × Book value at beginning of year.
– Pattern: A fixed percentage of the (declining) book value each year; dollar amounts fall over time.
– Note: Total accumulated depreciation increases each year, but annual depreciation declines.
3) Double‑declining balance (DDB)
– Formula: Rate = 2 × (1 / Useful life). Depreciation = Rate × Beginning‑of‑year book value. Stop or adjust when book value reaches salvage.
– Pattern: An “accelerated” method that front‑loads expense relative to straight‑line.
4) Sum‑of‑the‑years’ digits (SYD)
– Steps: Compute sum of years (for n years: n + (n−1) + … + 1). For year k (starting at largest remaining life), fraction = Remaining life / Sum. Multiply fraction × (Cost − Salvage).
– Pattern: Accelerated: higher expense early, lower later.
5) Units of production (usage‑based)
– Formula: Depreciation = (Units used this period / Total estimated units) × (Cost − Salvage).
– Pattern: Expense varies with actual usage (miles, hours, units produced).
6) Half‑year convention (practical recognition)
– Rule: Record one‑half of a full year of depreciation in the acquisition year and one‑half in the final year. Used to approximate partial‑year usage without tracking exact months.
Depreciation versus accumulated depreciation
– Depreciation expense: the amount charged to the income statement for a single period.
– Accumulated depreciation: the cumulative total of depreciation expense from acquisition to a point in time.
Accounting adjustments and estimates
– Changes in estimated useful life or salvage value are handled prospectively: revise remaining depreciation going forward; do not restate prior periods.
– If an asset is disposed of or retired, remove both the asset cost and its accumulated depreciation; recognize any gain or loss on disposal.
Is accumulated depreciation an asset or a liability?
– It is not an asset or a liability; it is a contra‑asset account that reduces the carrying amount of an asset.
Checklist: calculating and recording accumulated depreciation
1. Identify the asset’s historical cost (purchase price plus capitalizable costs).
2. Estimate salvage (residual) value at end of useful life.
3. Estimate useful life (years or total units of output).
4. Choose a depreciation method consistent with how the asset’s economic benefits are consumed.
5. Compute annual (or period) depreciation using the chosen formula.
6. Record journal entry each period: Debit Depreciation Expense, Credit Accumulated Depreciation.
7. Update accumulated depreciation on the balance sheet to reflect the cumulative total.
8. Review useful life and salvage value periodically; adjust prospectively if estimates change.
Worked numeric examples
Example A — Straight‑line (building)
– Cost = $250,000; Salvage = $10,000; Useful life = 20 years.
– Depreciable base = 250,000 − 10,000 = 240,000.
– Annual depreciation = 240,000 / 20 = $12,000.
– After 7 years: Accumulated depreciation = 12,000 × 7 = $84,000. Net book value = 250,000 − 84,000 = $166,000.
Example B — Units of production (vehicle)
– Cost = $90,000; Salvage = $10,000; Depreciable base = 80,000. Estimated life = 80,000 miles.
– Year 1 use = 8,000 miles → Year 1 depreciation = (8,000 / 80,000) × 80,000 = $8,000.
– Year 2 use = 20,000 miles → Year 2 depreciation = (20,000 / 80,000) × 80,000 = $20,000.
– Accumulated depreciation after Year 2 = 8,000 + 20,000 = $28,000. Net book value = 90,000 − 28,000 = $62,000.
Fast facts
– Accumulated depreciation can only decrease when an asset is sold, retired, or when a correcting accounting entry is made.
– “Accelerated depreciation” describes methods (DDB, SYD) that recognize more expense early in an asset’s life.
Presentation and journal entry (example)
– Periodic journal entry: Debit Depreciation Expense; Credit Accumulated Depreciation.
– Balance sheet: Report asset at historical cost, show accumulated depreciation below it, and disclose net book value.
Sources for further reading
– Investopedia — Accumulated Depreciation overview: https://www.investopedia.com/terms/a/accumulated-depreciation.asp
– Financial Accounting Standards Board (FASB): https://www.fasb.org
– IFRS Foundation — International accounting standards for property, plant and equipment: https://www.ifrs.org
– U.S. Securities and Exchange Commission (SEC) — Financial reporting basics: https://www.sec.gov/investor/pubs/financial.htm
– IRS Publication 946 — How to depreciate property (tax guidance): https://www.irs.gov/publications/p946
Educational disclaimer
This explanation is for educational purposes and does not constitute individualized accounting or tax advice. Companies should follow applicable accounting standards (GAAP or IFRS) and consult a qualified accountant or tax advisor for specific situations.