Accumulated Depreciation

What is Accumulated Depreciation?

Accumulated depreciation is the total sum of all of the depreciation over its useful life up to a specific point in time.

When an asset is purchased for a business, it is brand new. Over time, it wears down and loses its market value. This loss in value is recorded as accumulated depreciation on the balance sheet.

Common types of assets that can be depreciated are:

• Equipment (e.g., manufacturing equipment, construction equipment)
• Vehicles (e.g., cars, trucks)
• Buildings (e.g., office, storage)
• Furniture (e.g., chairs, phones, tables)

Methods to Calculate Accumulated Depreciation

Now that you have a basic understanding of accumulated depreciation, let's focus on different methods of recognizing and calculating it.

Generally, six methods are commonly used to calculate accumulated depreciation for an asset. Let’s understand them below:

Straight-line balance

Straight-line balance is probably the simplest of all methods. The idea is to recognize the depreciation proportionally, in equal amounts, according to how many periods are of the estimated useful life of an asset.

Also, if a salvage value is estimated at the end of the asset's useful life, it will be subtracted from the depreciable base.

Here is a general formula to calculate straight-line depreciation for an individual period:

Depreciation Expense = (Depreciation Base - Salvage Value) / Asset's Useful Life

These depreciation charges are then added up to arrive at the accumulated depreciation.

Declining Balance Method

In contrast to the straight-line method, depreciation is calculated as a percentage of an asset's remaining life in the declining balance method.

In this method, depreciation decreases over time because it is calculated as a fixed percentage of the asset's decreasing book value.

Here is the formula for accumulated depreciation:

Depreciation Expense = Current Book Value * Depreciation Rate

After calculating the depreciation sum for all periods, we will arrive at the total accumulated depreciation.

Double-Declining Balance Method

The double-declining balance method allocates a higher depreciation expense in the early years of an asset's life and a lower expense in later years. This method doubles the rate of depreciation calculated using the straight-line method.

It is beneficial for assets that quickly lose value or become obsolete. The annual depreciation expense is determined by using a fixed rate on the asset’s book value at the start of each year. 

This method leads to higher depreciation costs in the early years and gradually lowers expenses as the asset gets older.

To calculate, the formula is:

Depreciation Expense = 2 * ((Asset Cost - Residual Value) / Useful Life of An Asset)

As in other cases, the sum of depreciation expenses makes up the accumulated depreciation value.

Sum-of-the-Years'-Digits Method

The method's general idea is to record more depreciation in the earlier years and more in the later years.

To do so, the formula divides each period's digit by the sum of the total digits and uses the ratio to multiply the depreciable base.

The formula is shown below:

Depreciable Base * (Inverse Year Number / The Sum of Years' Digits)

Units of Production Methods

Another method of recognizing depreciation is the units of production method. Still, compared to the other methods, it recognizes depreciation based on the actual use of each period instead of estimating it.

Here is the formula for calculating depreciation:

Depreciation = (Number of Units Consumed / Total Units to be Consumed) * Depreciation Base

Half Year Recognition

The last common method of recognizing depreciation is to take half of the depreciable base and recognize it in the first year; the remaining half is recognized in the last period of useful life.

Accumulated Depreciation Example

Let's now look at an imaginary company.

First, the picture shows that depreciation expense is recognized on the income statement for each year, and in each period, the depreciation adds to the total balance of accumulated depreciation.

Since accumulated depreciation is a contra asset, it increases as the years go by, decreasing an asset's value until it equals zero or salvage value at the end of its useful life.

At the end of its book life, an asset can seem to have no use anymore. Still, in fact, in most cases, it can still be used since it is impossible for accountants to estimate how many years an asset will actually last exactly.

Depreciation vs. Accumulated Depreciation

While accumulated depreciation and depreciation are similar terms with a common idea behind them, they differ in purposes and are located on different financial statements.

Depreciation is an item on the income statement. Each time it is recorded, it represents the loss of value for that specific period of the asset's life.

On the other hand, accumulated depreciation is a contra asset that reduces the asset's value by the sum of the depreciation for all of the combined periods.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Bad Debt Expense
• Capitalizing R&D Expenses
• Depreciated Cost
• Depreciation Expense
• Depreciation Methods