What Is Accumulated Depreciation?

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The accumulated depreciation account is an asset account with a credit balance (also known as a contra asset account). If this derecognition were not completed, a company would gradually build up a large amount of gross fixed asset cost and accumulated depreciation on its balance sheet. Many companies rely on capital assets such as buildings, vehicles, equipment, and machinery as part of their operations. In accordance with accounting rules, companies must depreciate these assets over their useful lives.

Meanwhile, its balance sheet is a life-to-date running total that is not clear at year-end. Therefore, depreciation expense is recalculated every year, while accumulated depreciation is always a life-to-date running total. Once the balance of the asset account is zeroed, then no further entry concerning the accumulated depreciation of that asset will be passed. This is because the accumulated depreciation account balance cannot be more than that of the balance of the underlying asset account.

How to calculate accumulated depreciation

The debit and credit are entries in a double-entry system that are made in account ledgers to account for the changes in value that result from business transactions. A credit entry would always add a negative number to the journal while a debit entry would add a positive number to the journal. Therefore, a debit will always be positioned on the left-hand side of the ledger whereas a credit will always be positioned on the right-hand side of the ledger. In other words, the accumulated depreciation will usually show up as negative figures below the fixed assets on the balance sheet like in the sample picture below. Likewise, the normal balance of the accumulated depreciation is on the credit side.

Instead, the company will change the amount of accumulated depreciation recognized each year. This change is reflected as a change in accounting estimate, not a change in accounting principle. For example, say a company was depreciating a $10,000 asset over its five-year useful life with no salvage value. Using the straight-line method, an accumulated depreciation of $2,000 is recognized. Under the declining balance method, depreciation is recorded as a percentage of the asset’s current book value. Because the same percentage is used every year while the current book value decreases, the amount of depreciation decreases each year.

• Let’s say as an example that Exxon Mobil Corporation (XOM) has a piece of oil drilling equipment that was purchased for $1 million.
• The company can calculate the accumulated depreciation with the formula of depreciation expense plus the depreciated amount of fixed asset that the company have made so far.
• Therefore, the accumulated depreciation as a contra-asset account offsets the value of the asset that it is depreciating and as such is reported as a negative balance on the balance sheet under the long-term assets section.
• Depreciation expense is a portion of the capitalized cost of an organization’s fixed assets that are charged to expense in a reporting period.
• Accumulated depreciation has a natural credit balance (as opposed to assets that have a natural debit balance).

At the end of the accounting year, the debit balances in the expense account will be closed and transferred to the owner’s capital account or retained earnings (stockholders’ equity account), thereby reducing equity. Also, expenses increase with a debit entry, thus, in order to increase a depreciation expense account, it has to be debited. Small businesses have fixed assets that can be depreciated such as equipment, tools, and vehicles. For each of these assets, accumulated depreciation is the total depreciation for that asset up to and including the current accounting period.

What causes a reduction in Accumulated Depreciation?

Now assume that the company sells one piece of equipment that had a cost of $50,000 and had accumulated depreciation of $40,000 at the end of the previous accounting year. The first step is to record this year’s depreciation for the equipment being sold. Let’s assume the depreciation from the end of the previous accounting year until the date of the sale is $500. Therefore, the credit balance for this one piece of equipment at the time of the sale is $40,500.

Some accounting textbooks state that the cost of an expenditure that extends the useful life of an asset should be debited to the accumulated depreciation account instead of the asset account. Such an entry will also reduce the credit balance in the accumulated depreciation account. Depreciation expense in this formula is the expense that the company have made in the period. On the other hand, the depreciated amount here is the total amount of depreciation expense that the company has charged to the income statement so far on the particular fixed asset including those in the prior accounting periods. The balance in the accumulated depreciation account will increase more quickly if a business uses an accelerated depreciation methodology, since doing so charges more of an asset’s cost to expense during its earlier years of usage. The use of accelerated depreciation makes it more difficult to judge how old a reporting entity’s fixed assets are, since the proportion of accumulated depreciation to fixed assets is higher than would normally be the case.

What is depreciation expense?

Because the depreciation process is heavily rooted in estimates, it’s common for companies to need to revise their guess on the useful life of an asset’s life or the salvage value at the end of the asset’s life. Accumulated depreciation is dependent on salvage value; salvage value is determined as the amount a company may expect to receive in exchange for selling an asset at the end of its useful life. In five basic elements of accounting for any business Year 1, Company ABC would recognize $2,000 ($10,000 x 20%) of depreciation and accumulated depreciation. For example, imagine Company ABC buys a company vehicle for $10,000 with no salvage value at the end of its life. These methods are allowable under generally accepted accounting principles (GAAP). Calculate the accumulated depreciation and net book value of the equipment at the end of the third year.

How to Calculate Accumulated Depreciation

When an asset is disposed of (sold, retired, scrapped) the credit balance in Accumulated Depreciation is reduced when the asset’s credit balance is removed by debiting Accumulated Depreciation. 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. 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.

As a result, companies must recognize accumulated depreciation, the sum of depreciation expense recognized over the life of an asset. Accumulated depreciation is reported on the balance sheet as a contra asset that reduces the net book value of the capital asset section. The yearly depreciation expense then adds to the balance of the accumulated depreciation account.

So, as depreciation expenses continue to be recorded, the amount of accumulated depreciation for an asset or group of assets will increase over time. Therefore, leading to a decrease in the book value of fixed assets of the company until the book value of the asset becomes zero. Since fixed assets on the balance sheet have a debit balance, by recording accumulated depreciation as a credit balance, the fixed asset can be offset. Therefore, the accumulated depreciation as a contra-asset account offsets the value of the asset that it is depreciating and as such is reported as a negative balance on the balance sheet under the long-term assets section. A credit entry will increase equity, revenue or liability while decreasing expense or asset accounts.

Debiting Accumulated Depreciation

The majority of companies depend on capital assets for part of their business operations and in accordance with accounting rules, they must depreciate these assets over their useful lives. As a result, they have to recognize accumulated depreciation which is reported as a contra asset on the balance sheet. The Accumulated Depreciation account on the other hand is a permanent account and as such is a balance sheet account. Accumulated depreciation is a contra-asset account whose credit balance gets larger every year.

Even though accumulated depreciation will still increase, the amount of accumulated depreciation will decrease each year. In business, every transaction transfers value from credited accounts to debited accounts. Therefore, a credit entry will always add a negative number to the journal whereas a debit entry will add a positive number. A debit will always be positioned on the left side of the account and a credit on the right side of the account.