What Is Accumulated Depreciation?
Accumulated depreciation is the cumulative depreciation of an asset up to a single point in its life. An asset's carrying value on the balance sheet is the difference between its purchase price and accumulated depreciation. A company buys and holds an asset on the balance sheet until the salvage value matches the carrying value.
Breaking Down Accumulated Depreciation
Accumulated deprecation is relevant for assets that are capitalized. The other type of asset is an operating asset, which is expensed in the year it's purchased, as it is generally sold or used within a year of purchase.
Capitalized assets provide value for more than one year, and accounting rules dictate that expenses and sales are matched in the period in which they are incurred. As a solution to this matching problem for capitalized assets, accountants use a process called depreciation. Depreciation expenses a portion of the cost of the asset in the year it is purchased and for the rest of the asset's useful life. Accumulated depreciation is the total amount that the asset has been depreciated over the asset's life.
Accumulated depreciation is important for capitalized assets.
Accumulated Depreciation Example
Straight-line depreciation expense is calculated by dividing the difference between the cost of the asset and its salvage value by the asset's useful life. In this example, the cost of the asset is the purchase price, the salvage value is the value of the asset at the end of its life, also referred to as scrap value, and the useful life is the number of years the asset is expected to provide value.
Company A buys a piece of equipment with a useful life of 10 years for $110,000. The equipment has a salvage value of $10,000 at the end of its useful life. The equipment is going to provide the company with value for the next 10 years, so analysts expense the cost of the equipment over the next 10 years. Straight-line depreciation is calculated as $110,000 minus $10,000 divided by 10, or $10,000 a year. This means the company will depreciate $10,000 for the next 10 years until the book value of the asset is $10,000.
Each year the contra asset account referred to as accumulated depreciation increases by $10,000. For example, at the end of five years, the annual depreciation expense is still $10,000, but accumulated depreciation has grown to $50,000. That is, accumulated depreciation is a cumulative account. It is credited each year as the value of the asset is written off and remains on the books until the asset is sold. It is important to note that accumulated depreciation can't be more than the asset's cost even if the asset is used after its useful life.