A fixed asset costing 30 000 is depreciated over its estimated useful life of 15 years

Accumulated depreciation is the total amount of depreciation of a company's assets, while depreciation expense is the amount that has been depreciated for a single period. Depreciation is an accounting entry that represents the reduction of an asset's cost over its useful life.

In other words, depreciation spreads out the cost of an asset over the years, allocating how much of the asset that has been used up in a year, until the asset is obsolete or no longer in use. Without depreciation, a company would incur the entire cost of an asset in the year of the purchase, which could negatively impact profitability.

Put another way, accumulated depreciation is the total amount of an asset's cost that has been allocated as depreciation expense since the asset was put into use.

Key Takeaways

• Depreciation is an accounting method that spreads out the cost of an asset over its useful life.
• Depreciation expense is the cost of an asset that has been depreciated for a single period, and shows how much of the asset's value has been used up in that year.
• Accumulated depreciation is the total amount of depreciation expense that has been allocated for an asset since the asset was put into use.
• Depreciation expense is recognized on the income statement as a non-cash expense that reduces the company's net income.
• Accumulated depreciation appears in a contra asset account on the balance sheet reducing the gross amount of fixed assets reported.

What Is Accumulated Depreciation?

The accumulated depreciation account is a contra asset account on a company's balance sheet. It represents a credit balance. It appears as a reduction from the gross amount of fixed assets reported. Accumulated depreciation specifies the total amount of an asset's wear to date in the asset's useful life.

The amount of accumulated depreciation for an asset or group of assets will increase over time as depreciation expenses continue to be recorded. When an asset is eventually sold or put out of use, the accumulated depreciation associated with that asset will be reversed, eliminating all records of the asset from the company's balance sheet.

What Are Depreciation Expenses?

Depreciation expenses, on the other hand, are the allocated portion of the cost of a company's fixed assets for a certain period. Depreciation expense is recognized on the income statement as a non-cash expense that reduces the company's net income or profit. For accounting purposes, the depreciation expense is debited, and the accumulated depreciation is credited.

Depreciation expense is considered a non-cash expense because the recurring monthly depreciation entry does not involve a cash transaction. Because of this, the statement of cash flows prepared under the indirect method adds the depreciation expense back to calculate cash flow from operations. The methods used to calculate depreciation include straight line, declining balance, sum-of-the-years' digits, and units of production.

Depreciation and Accumulated Depreciation Example

Tracking the depreciation expense of an asset is important for reporting purposes because it spreads the cost of the asset over the time it's in use.

The simplest way to calculate this expense is to use the straight-line method. The formula for this is (cost of asset minus salvage value) divided by useful life.

Say a company spent $50,000 for equipment for long-term use in its operations. It estimates that the salvage value will be $2,000 and the asset's useful life, 15 years. The depreciation expense per year would be $3,200.

($50,000 - $2,000)/15 = $3,200

Accumulated depreciation totals depreciation expense since the asset has been in use. Thus, after five years, accumulated depreciation would total $16,000.

$3,200 x 5 = $16,000

Accumulated Depreciation and Book Value

Accumulated depreciation is used to calculate an asset’s net book value, which is the value of an asset carried on the balance sheet. The formula for net book value is cost an asset minus accumulated depreciation.

For example, if a company purchased a piece of printing equipment for $100,000 and the accumulated depreciation is $35,000, then the net book value of the printing equipment is $65,000.

$100,000 - $35,000 = $65,000.

Accumulated depreciation cannot exceed an asset’s cost. If an asset is sold or disposed of, the asset’s accumulated depreciation is removed from the balance sheet. Net book value isn’t necessarily reflective of the market value of an asset.  

Depreciation expense is recorded on the income statement as an expense or debit, reducing net income. Accumulated depreciation is not recorded separately on the balance sheet. Instead, it's recorded in a contra asset account as a credit, reducing the value of fixed assets.

Depreciation Method Examples

The four methods allowed by generally accepted accounting principles (GAAP) are the aforementioned straight-line, declining balance, sum-of-the-years' digits (SYD), and units of production.

To see how the calculations work, let's use the earlier example of the company that buys equipment for $50,000, sets the salvage value at $2,000 and useful life at 15 years. In addition, the depreciation rate is 20%. The estimate for units to be produced over the asset's lifespan is 100,000. Actual units produced equals 5,000.

The calculation for the straight-line method (previously shown) is (cost of asset - salvage value)/useful life:

($50,000 - $2,000)/15 = $3,200

$3,200 will be the annual depreciation expense for the life of the asset.

The calculation for the declining balance method is current book value x depreciation rate:

$50,000 x .20 = $10,000

The first year's depreciation expense would be $10,000. Subsequent years' expenses will change based on the changing current book value. For example, in the second year, current book value would be $50,000 - $10,000, or $40,000. Thus, depreciation expense would decline to $8,000 ($40,000 x .20).

The calculation for the sum-of-the-years' digits method is (remaining lifespan/SYD) x (asset cost - salvage cost):

Given an SYD of 120 (1+2+3+4+5+6+7+8+9+10+11+12+13+14+15), (15/120) x ($50,000 - $2,000) = $6,000.

The first year's depreciation expense would be $6,000. Subsequent years' expenses will change as the figure for the remaining lifespan changes. So, depreciation expense would decline to $5,600 in the second year (14/120) x ($50,000 - $2,000).

The calculation for the units of production method is (asset cost - salvage value)/estimated units over lifespan x actual units produced:

($50,000 - $2,000)/100,000 x 5,000 = $2,400.

The first year's depreciation expense would be $2,400. Subsequent results will vary as the number of units actually produced varies.

What Is the Basic Formula for Calculating Accumulated Depreciation?

Accumulated depreciation is the total amount of depreciation expense recorded for an asset on a company's balance sheet. It is calculated by summing up the depreciation expense amounts for each year.

Is Accumulated Depreciation an Asset or Liability?

Accumulated depreciation is recorded in a contra asset account, meaning it has a credit balance, which reduces the gross amount of the fixed asset. As a result, it is not recorded as an asset or a liability.

Is Depreciation Expense an Asset or Liability?

Depreciation expense is recorded on the income statement as an expense and represents how much of an asset's value has been used up for that year. As a result, it is neither an asset nor a liability.

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