Why Is Accumulated Depreciation a Credit Balance?
Accumulated depreciation is the cumulative depreciation of an asset that has been recorded. Fixed assets like property, plant, and equipment are long-term assets. Depreciation expenses a portion of the cost of the asset in the year it was purchased and each year for the rest of the asset's useful life. Accumulated depreciation allows investors and analysts to see how much of a fixed asset's cost has been depreciated.
- Accumulated depreciation is the running total of depreciation that has been expensed against the value of an asset.
- Fixed assets are recorded as a debit on the balance sheet while accumulated depreciation is recorded as a credit–offsetting the asset.
- Since accumulated depreciation is a credit, the balance sheet can show the original cost of the asset and the accumulated depreciation so far.
- The net difference or remaining amount that has yet to be depreciated is the asset's net book value.
Understanding Accumulated Depreciation
Instead of expensing the entire cost of a fixed asset in the year it was purchased, the asset is depreciated. Depreciation allows a company to spread out the cost of an asset over its useful life so that revenue can be earned from the asset. Depreciation prevents a significant cost from being recorded–or expensed–in the year the asset was purchased, which, if expensed, would impact net income negatively.
Accumulated depreciation is an account containing the total amount of depreciation expense that has been recorded so far for the asset. In other words, it's a running total of the depreciation expense that has been recorded over the years.
Why Accumulated Depreciation is a Credit Balance
Each year, the depreciation expense account is debited, expensing a portion of the asset for that year, while the accumulated depreciation account is credited for the same amount. Over the years, accumulated depreciation increases as the depreciation expense is charged against the value of the fixed asset. However, accumulated depreciation plays a key role in reporting the value of the asset on the balance sheet.
Fixed assets have a debit balance on the balance sheet. By having accumulated depreciation recorded as a credit balance, the fixed asset can be offset. In other words, accumulated depreciation is a contra-asset account, meaning it offsets the value of the asset that it is depreciating. As a result, accumulated depreciation is a negative balance reported on the balance sheet under the long-term assets section.
However, the fixed asset is reported on the balance sheet at its original cost. Accumulated depreciation is recorded as well, allowing investors to see how much of the fixed asset has been depreciated. The net difference or remaining amount that has yet to be depreciated is the asset's net book value.
In short, by allowing accumulated depreciation to be recorded as a credit, investors can easily determine the original cost of the fixed asset, how much has been depreciated, and the asset's net book value.
When an asset is retired or sold, the total amount of the accumulated depreciation associated with that asset is reversed, completely removing the record of the asset from a company's books.
Example of Accumulated Depreciation
Let's say as an example that Exxon Mobil Corporation (XOM) has a piece of oil drilling equipment that was purchased for $1 million. Over the past three years, depreciation expense was recorded at a value of $200,000 each year.
Below we see the running total of the accumulated depreciation for the asset.
The balance sheet would reflect the fixed asset's original price and the total of accumulated depreciation.
Since accumulated depreciation is a credit entry, the balance sheet can show the cost of the fixed asset as well as how much has been depreciated. From there, we can calculate the net book value of the asset, which in this example is $400,000.