## Accumulated Depreciation

Accumulated Depreciation

Accumulated depreciation is an account used to tally or keep track of the amount an asset depreciates. Accumulated depreciation is the accumulation of an asset’s estimated reduction in value.

The first thing you need to know before establishing an accumulated depreciation account is the amount an asset depreciates each year. Think of depreciation expense as a fixed asset’s estimated reduction in value each year.

Let’s assume your company purchases a computer system for \$3,000.  Also assume the useful life of the computer is estimated to be 3 years. Also consider, the computer was purchased on the first day of your company’s fiscal period and the half year rule is not used.  If we used the straight line method of depreciation, the computer’s depreciation expense each year would be \$1,000.  Note: Straight line depreciation simply applies an equal amount of depreciation in each year of the asset’s useful life.  In this case, you divide the estimated useful life of the computer (3 years) by the cost of the computer system (\$3,000).  The resulting figure of \$1,000 is the depreciation expense assigned to the computer for each year of its three year useful life.

Now that we know the depreciation expense each year, we can determine the accumulated deprecation of the computer.  Below shows the accumulated deprecation of computer over its three year useful life.

Accumulated Depreciation in Year 1 = \$1,000
Accumulated Depreciation in Year 2 = \$2,000
Accumulated Depreciation in Year 3 = \$3,000

At the end of year 3, the computer system is considered to have no book value.  In other words, from a book value point of view, the value of the computer is zero. Below shows how the accumulated depreciation account would appear on the balance sheet for each of the three years.

Accumulated Depreciation in the first year:

Computer Equipment                         \$3,000
Less: Accumulated Depreciation        \$1,000
Net book value of Computer              \$2,000

Accumulated Depreciation in the second year:

Computer Equipment                         \$3,000
Less: Accumulated Depreciation        \$2,000
Net book value of Computer              \$1,000

Accumulated Depreciation in the third year:

Computer Equipment                         \$3,000
Less: Accumulated Depreciation        \$3,000
Net book value of Computer              \$   0

The accumulated depreciation after the third year is \$3,000 which is the original value of the computer three years prior.  The depreciation expense, appearing on the company’s income statement, would be \$1,000 in year one, \$1,000 in year two and \$1,000 in the third year.

A number of questions relating to accumulated depreciation are often asked in forums and on blog posts including the following.

“is accumulated depreciation an asset”?
“is accumulated depreciation a liability”?
“is accumulated depreciation a current liability”?
“is accumulated depreciation an expense”?
“is accumulated depreciation an operating expense”?
“is accumulated depreciation a contra asset”?
“is accumulated depreciation an equity”?

Simply put, accumulated depreciation is not an asset, or a liability, or operating expense or equity.   Accumulated depreciation is a contra asset.  Accumulated deprecation appears under the fixed asset section of the balance sheet.  The value appearing in the accumulated depreciation account is subtracted from the original cost of the asset pool to arrive at the estimated value of the fixed asset pool.

A simple way to understand accumulated depreciation is to think of it as an accumulation of an asset’s depreciation expense or estimated reduction in value.  That said, you need to determine an asset’s depreciation expense first before you can determine the amount appearing in the accumulated depreciation account.

Now assume you hire another staff member and, as a result, you need to purchase a high end computer system for this new employee.  For simplicity, assume the new computer system was purchased exactly one year after the first computer system was purchased.  Other assumptions include:

- The cost of the second computer is \$6,000.
- Your accountant informs you the useful life of the second computer is also 3 years.
- Your accountant expects the computer will have no salvage value at the end of the computer’s useful life.
- Your accountant will continue to use the straight line method of depreciation.

Now we have enough information to determine the accumulated depreciation for the two computers.

Since the new computer was purchased exactly one year after the first computer was purchased, accumulated depreciation and deprecation expense will remain unchanged from the year one calculations above.   Moreover, deprecation expense and accumulated deprecation will be \$1,000 in year one.  Here’s how Accumulated Depreciation for the single computer appears on the balance sheet.

Accumulated Depreciation in the first year:

Computer Equipment                         \$3,000
Less: Accumulated Depreciation        \$1,000
Net book value of Computer              \$2,000

In year two, however, we have to consider the new computer valued at \$6,000 with an estimated useful life of 3 years.  The first thing we need to do is calculate the depreciation expense of the two computers.  To do this, we add the cost of the new computer which is \$6,000 to the original cost of the old computer which was \$3,000.  As a result, the value of the two computers collectively amount to \$9,000.  Since they both have an estimated useful life of three years, you simply divide the \$9,000 by three years.  The resulting figure is \$3,000 which represents the new annual depreciation expense for the two computer systems.  Now we can determine the accumulated depreciation for year two and year three.

Accumulated Depreciation in the second year:

Computer Equipment                                     \$9,000
Less: Accumulated Depreciation                    \$4,000
Net book value of Computer Equipment        \$5,000

The value of the Computer Equipment of \$9,000 consists of the cost of the first computer which is \$3,000 and the cost of the second computer which is \$6,000.  The Accumulated Deprecation of \$4,000 consists of the deprecation expense of the first computer in year one which was \$1,000 plus the new calculation of depreciation expense when considering the purchase of the second computer.  Recall from above the new calculation of deprecation expense amounts to \$3,000.  As a result, the accumulated depreciation in year two amounts to \$4,000 (\$1,000 + \$3,000).

Now let’s look at the accumulated depreciation account for the third year.

Accumulated Depreciation in the third year:

Computer Equipment                                        \$9,000
Less: Accumulated Depreciation                       \$7,000
Net book value of Computer Equipment           \$2,000

The accumulated depreciation in year three is simply determined by adding the new annual deprecation expense of \$3,000 to the balance appearing in the ending balance of the accumulated deprecation account at the end of the second year (IE \$4,000).  As a result, the accumulated deprecation for the third year totals \$7,000 (\$4,000 which is the ending balance of accumulated deprecation at the end of the second fiscal period + \$3,000 which is the annual deprecation expense when considering both computers).

Assuming no other computers or similar fixed asset were purchased, we can determine the amount that would appear on the balance sheet under the accumulated deprecation account for the fourth year. Below shows what values would appear within the accumulated depreciation account in the fourth year.

Computer Equipment                                        \$9,000
Less: Accumulated Depreciation                       \$9,000
Net book value of Computer Equipment           \$    0

Since the useful life of the first computer was three years, it is not considered in the fourth year.  In other words, the book value of the first computer at the end of the third fiscal year is zero and cannot be depreciated any further.  As a result, the accumulated depreciation in the fourth year will only involve the second computer.

Recall, the cost of the second computer was \$6,000 with a three year useful life.  Using the straight line method of depreciation, deprecation expense on this second computer is \$2,000 per year (the original cost of the second computer which was \$6,000 divide by the estimated useful life of the second computer which is 3 years = \$2,000 deprecation expense per fiscal year.

That said, accumulated depreciation in year four is determined by adding the annual deprecation expense of the second computer which amounts to \$2,000 to the balance appearing in the accumulated deprecation account at the end of the third year which is \$7,000.  As a result, the total accumulated depreciation in year four is \$9,000 (\$2,000 deprecation expense plus the accumulated depreciation appearing at the end of the third year of \$7,000 = \$9,000).  Therefore, the net book value of the two computers at the end of the fourth fiscal year is \$0.00 (as shown above).

For additional information on accumulated deprecation and depreciation expense, please refer to the section entitled, Balance Sheet Assets.

Let’s look at a new accumulated depreciation scenario.  Assume your business purchased the following fixed assets.

Office Desk                             \$4,500
Three Office Chairs                   1,300
Two Filing Cabinets                  1,200
Total Office Furniture              \$7,000

Let’s determine the accumulated depreciation on the office furniture using the following assumptions:

-    Your accountant suggests the Office Furniture has a useful life of 6 years.
-    According to your accountant, the salvage value of the office furniture after the 6 year estimated useful life of the office furniture is expected to be \$1,000.  Meaning, your company should be able to sell the office furniture for \$1,000 after six years.
-    Your accountant suggests using the straight line method of depreciation to depreciate the office furniture and to estimate the accumulated depreciation.

Using the above data, let’s determine the accumulated depreciation of the office furniture for the next six years.  This calculation assumes no other related office furniture is purchased in the next six years.

This situation introduces a new accounting term entitled, salvage value.  When calculating deprecation expense and accumulated depreciation, your accountant will need to consider the estimated salvage value.

In this situation, the office furniture is expected to have a salvage value of \$1,000. Meaning, your company should be able to sell the office furniture for \$1,000 after six years.   Having this information, the salvage value is subtracted from the original cost of the office furniture to arrive at \$6,000 (IE \$7,000 - \$1,000 salvage value = \$6,000).  Now divide the \$6,000 by the estimated useful life of the office furniture which is three years.  The resulting figure is \$1,000 which represents the depreciation expense per year for the office furniture.  Therefore, the balance sheet will show the following balances under the accumulated depreciation for office equipment; assuming no other office equipment was purchased during the next 6 years.

Accumulated Depreciation in the first year:

Office Furniture                                     \$7,000
Less: Accumulated Depreciation           \$1,000
Net book value of Office Furniture        \$6,000

Accumulated Depreciation in the second year:

Office Furniture                                     \$7,000
Less: Accumulated Depreciation           \$2,000
Net book value of Office Furniture        \$5,000

Accumulated Depreciation in the third year:

Office Furniture                                     \$7,000
Less: Accumulated Depreciation           \$3,000
Net book value of Office Furniture        \$4,000

Accumulated Depreciation in the fourth year:

Office Furniture                                     \$7,000
Less: Accumulated Depreciation           \$4,000
Net book value of Office Furniture        \$3,000

Accumulated Depreciation in the fifth year:

Office Furniture                                     \$7,000
Less: Accumulated Depreciation           \$5,000
Net book value of Office Furniture        \$2,000

Accumulated Depreciation in the sixth year:

Office Furniture                                     \$7,000
Less: Accumulated Depreciation           \$6,000
Net book value of Office Furniture        \$1,000

Recall, at the end of the estimated useful life of the office furniture (6 years), the accountant estimated the salvage value of the office furniture would be \$1,000.  As a result, the net book value, appearing under the Fixed Assets section of the balance sheet at the end of the sixth year, is \$1,000.

This concludes our discussion on accumulated depreciated.  Just remember, accumulated depreciation is simply an account used to keep track of the depreciation expense of a fixed asset over its useful life.  In other words, accumulated depreciation is the “accumulation” of an asset’s estimated reduction in value throughout the years.

Categories: Financial