What is Accumulated Depreciation?

Accumulated depreciation is like the empty space of a frozen lemonade cup…

If you order a frozen lemonade cup on a hot summer day, you start with a full cup. The moment you start enjoying your treat, the contents of your cup will go down. Your cup may say 12 fluid ounces before you start, but after you eat some, it declines to maybe 7 fluid ounces. That empty part of your cup - the 5 fluid ounces you’ve eaten - is like accumulated depreciation, the total drop in the cup’s value.

Accumulated depreciation reflects the total loss in the value of a fixed physical asset due to wear and tear as it gets older.

Each period that the asset is used, the owner records an expense for depreciation, to represent the loss in value of the asset during that period. Accumulated depreciation is the total of those costs up until the present. When you subtract accumulated depreciation from the initial value of the asset, you get the current value of the asset as carried on the company’s balance sheet.

Depreciation and accumulated depreciation apply to long-term physical assets, known as fixed assets. Intangible assets like patents, copyrights, and trademarks have their value gradually reduced through a similar but separate process known as amortization.

Accumulated depreciation is listed on the asset side of a company’s balance sheet under the section for fixed assets, also known as non-current assets. But it is a “contra asset” - an asset account that offsets and reduces another asset account. Typically it offsets and reduces the value of a company’s property, plant, and equipment.

Accumulated depreciation increases each year as more depreciation expenses are recorded and the asset’s value declines. By subtracting accumulated depreciation from the asset’s original value, you can determine the asset’s book value — its current net worth on the balance sheet. But accumulated depreciation can’t exceed the asset’s original value - if the initial value of a piece of equipment were to be $150,000, then accumulated depreciation wouldn’t be greater than $150,000.

On the balance sheet, a company may provide a consolidated line item that shows the current value of a fixed asset, after deducting accumulated depreciation (e.g., “property and equipment, net”). Alternatively, it may provide a breakdown of the asset’s original value, its accumulated depreciation as a contra asset, and its current net value.

Imagine a florist owns a delivery van with an initial value of $30,000 and a salvage value of $3,000 — the value for which the florist can sell the van at the end of its useful life.

That means the florist can depreciate the van by up to $27,000 - its original value minus its salvage value: $30,000 - $3,000 = $27,000.

The florist decides to reduce the van’s value by the same amount every year, a method known as straight-line depreciation. If the van’s useful life is nine years, the value of the van depreciates at the rate of $3,000 per year ($27,000 / nine years).

Let’s review how the florist makes the entry for the first year’s depreciation expense and accumulated depreciation on the company’s ledger.

(Even though it reduces the van’s value, accumulated depreciation is a credit here because the year’s depreciation expense increases the amount of accumulated depreciation.)

On the balance sheet’s non-current asset section, the florist would list the vehicle as:

By the end of the second year, the florist would take a second yearly depreciation expense of $3,000. Together with the first year’s depreciation of $3,000, the total accumulated depreciation would then be $6,000. The balance sheet would reflect the increase in accumulated depreciation to $6,000:

The florist would continue depreciating the van for another seven years, gradually reducing the van’s value until it reaches its salvage value of $3,000. By the end of the seventh year, the accumulated depreciation of the vehicle would be $27,000 on the balance sheet:

Accumulated depreciation is an asset under generally accepted accounting principles (GAAP) — a commonly followed collection of accounting guidelines that organizations use in reporting their financial numbers.

However, accumulated depreciation is a contra asset — an asset account that offsets another asset, most commonly property, plant, and equipment. Its natural balance value is a credit, because the amount of accumulated depreciation increases over time; it’s shown as a negative number in the asset section of the balance sheet because it reduces the value of the associated asset.

Depreciation is the expense a company records each quarter or year to reflect the loss in value of a fixed asset during that period. Accumulated depreciation is the total of all such expenses the company has recorded related to that asset up to the present.

Depreciation and accumulated depreciation are different types of accounts. Depreciation is an expense, on a company’s income statement. Accumulated depreciation is an asset, but of a special type: It’s a contra asset that offsets the value of a fixed asset. Since they’re different account types, depreciation and accumulated depreciation have different natural balances and are affected differently by debit and credit entries. For instance, while accumulated depreciation reduces the value of an asset, its amount increases over time, and its natural balance is regarded as a credit.

An asset’s accumulated depreciation depends on two factors: the length of its useful life and the amount of depreciation you record each year.

You can choose your asset’s useful life based either on reasonable information - like data and guidelines from manufacturers, professional and industry organizations, and governments - or on information from the Internal Revenue Service (IRS), which establishes guidelines for the useful life of different types of assets, from office furniture to oil-drilling equipment to dairy cattle.

The IRS uses a system known as the Modified Accelerated Cost Recovery System (MACRS), which is used for depreciation of most physical assets that companies have begun using since the mid-1980s. MACRS can offer companies a tax advantage, because the guidelines for useful lives of assets that the IRS sets are often shorter than the period in which the asset can actually be used. That can bring companies greater tax deductions in the earlier years of an asset’s life: The shorter life means each year’s depreciation expenses are higher, reducing the amount of profits on which they pay taxes.

For example, Consumer Reports estimates the average useful life of a car to be over 11 years. However, the IRS sets the useful life of a car at five years under MACRS.

Once you have your asset’s useful life, you’re ready to calculate the annual depreciation and accumulated depreciation.

Two commonly used methods for calculating annual depreciation are straight-line depreciation, which spreads depreciation evenly over an asset’s useful life, and declining balance (DB) depreciation, which accelerates depreciation and front-loads it to the earliest years that the asset is in use.

Straight-line depreciation reduces an asset’s value by the same amount every year over its useful life. If your asset has a salvage value - the amount for which you can sell it when its useful life is over - you subtract the salvage value from the asset’s original cost, and then divide the result by the number of years in the asset’s useful life to get the amount of depreciation for each year.

Example of accumulated depreciation calculation using straight-line depreciation

Let’s assume you have a $10,000 computer, bought at the start of a year, with a useful life of three years and a salvage value of $1,000. So this is how the calculation would work:

To calculate your depreciation per year, first subtract the amount in cell B3 from the amount in cell B1 to get the total useful value over the asset’s life. In this case, that’s $10,000 - $1,000 - $9,000. Then divide it by the amount in cell B2 to get the yearly depreciation - that’s $9,000 / 3 = $3,000. That amount goes in cell B4.

To calculate accumulated depreciation, first choose the number of years you want to calculate it for. Let’s use two years for this example, so input 2 years on cell B5.

So accumulated depreciation would be the $3,000 you got for depreciation per year, times two years, equals $6,000, the amount that would go in cell B6.

This method speeds up depreciation, allowing companies to record higher depreciation expenses in the earliest years that an asset is in use. That means they pay less in taxes upfront, though the overall amount of taxes over time remains the same. It’s useful for depreciating computers and other technological assets that can become outdated quickly as technology advances.

DB itself has different variations. The two most common are the 200% declining balance method and the 150% declining balance method. The percentages refer to the amount of depreciation you take each year: 200% or 150% of the amount you’d take under the straight-line method, until your depreciable value is so low it’s less than the amount you’d have to take under the straight-line method.

Also, you measure your depreciation for a given year based not on your original cost, as you would under the straight-line method, but on the value of the asset at the start of that year, and thus the remaining amount that the asset has to be depreciated.

Let’s assume that you have a $25,000 vehicle, bought at the start of a year, with a useful life of 10 years and no salvage value. You’re using the 200% declining balance method, and you want to calculate accumulated depreciation for the first two years.

Under the straight-line method, depreciation would be $2,500 a year - the $25,000 cost divided by 10 years. So under the 200% declining balance method, depreciation in year 1 would be 200% of that, or $5,000.

Then, to get the depreciation in year 2, you take the vehicle’s $20,000 value at the start of the year (i.e., the $25,000 original value minus the first year’s $5,000 depreciation). Then divide that by 10 to get the straight-line rate, or $2,000, and take 200% of that - so that’s $4,000.

Thus, accumulated depreciation for the first two years would be the $5,000 for year 1 plus the $4,000 for year 2, or $9,000.