In accounting, depreciation is the systematic allocation of the cost of a tangible asset over its estimated useful life. Depreciation recognizes the gradual consumption, wear and tear, or obsolescence of these assets over time. This allows for a more accurate reflection of the asset’s decreasing value as it contributes to the generation of revenue for the business.
What Is Accumulated Depreciation?
Accumulated Depreciation is a contra-asset account that represents the total depreciation expense recognized for an asset since the acquisition date. The accumulated depreciation amount is a running total that continues to grow until the asset is fully depreciated or disposed of.
In other words, 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 Accumulated Depreciation is subtracted from the original cost of the asset to determine its carrying or book value (the remaining value of the asset after accounting for the depreciation that has been recognized).
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.
While Accumulated Depreciation appears on the balance sheet, the corresponding depreciation expense is reflected on the income statement. The net effect is a reduction in the asset’s book value and a decrease in the reported net income.
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.
What is Depreciation Expense?
Depreciation Expense is an accounting method used to allocate the cost of a tangible asset over its useful life. Tangible assets, such as buildings, vehicles, machinery and equipment, are expected to provide economic benefits over a specific period.
When a business acquires a tangible asset, its cost is not always recognized as an immediate expense. Instead, the cost is spread out over the asset’s estimated useful life through the process of depreciation.
Depreciation Expense is reported on the income statement as an operating expense. It reduces the net income for the period, reflecting the portion of the asset’s cost that is considered to be an expense during that specific time frame. For accounting purposes, the depreciation expense is debited, and the accumulated depreciation is credited.
While depreciation reduces the reported income, it does not involve the outflow of cash. It is a non-cash expense, meaning that the business is not physically spending money when recognizing depreciation on the income statement.
The calculation of depreciation often considers the estimated useful life of the asset and any residual value (the expected value of the asset at the end of its useful life). The methods used to calculate depreciation include straight line, declining balance, sum-of-the-years’ digits, and units of production.
The depreciation expense is subtracted from the original cost of the asset on the balance sheet. The resulting value is referred to as the book value, representing the asset’s carrying amount.
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
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.
Depreciation Expense vs Accumulated Depreciation: Key Differences
| Feature | Depreciation Expense | Accumulated Depreciation |
|---|---|---|
| Definition | Represents the portion of an asset’s cost allocated as an expense during a specific period. | Cumulative total of depreciation expense recognized from the acquisition of the asset to the current date. |
| Timing of Recognition | Recognized on the income statement in each accounting period. | Accumulates over time and is reported on the balance sheet. |
| Reported How? | As a credit. The amount appears on the balance sheet and offsets fixed assets. | As a debit. The amount appears on the income statement and is applied against income. |
| Nature | An operating expense. | Reduces the book value of the asset. |
| Reset Each Period | Starts afresh in each accounting period. | Accumulates continuously until the asset is fully depreciated or disposed of. |
| Presentation | Deducted from revenues to calculate net income. | Reduces the carrying amount of the asset on the balance sheet. |
| Taxes | Used to calculate the adjusted basis for the asset to determine a taxable gain if asset is sold; other aspects may apply, as well | Used as a tax deduction to reduce taxable income. |
| Calculation Basis | Calculated based on factors like cost, useful life, and residual value. | Cumulative total of depreciation expense recognized over the asset’s life. |
| Purpose | Reflects the cost allocation for a specific period. | Indicates the total depreciation recorded since the acquisition of the asset. |
| Final Recording | Amount is reversed when asset is sold or put out of use. | Expense allocation is ended when asset is sold or put out of use. |