Accumulated Depreciation Definition and Example

What Is Accumulated Depreciation?
Accumulated depreciation is a line item in a company’s financial statement that represents the decline in the value of an asset that a company owns. The simplest way to calculate accumulated depreciation is with the following formula:

Accumulated Depreciation = (Original Cost - Salvage Value) ÷ Life of the Asset × Years

Small businesses and corporations often own both tangible assets and intangible assets. Examples of tangible assets include computers, machinery, software, employee uniforms, and vehicles; intangible assets include patents and brand equity.

Tangible items will steadily lose market value over the asset’s life, and businesses can record this loss on financial statements as accumulated depreciation. For income tax purposes, this is a depreciation expense—an amount the company can partially deduct from its earnings because the asset’s book value is less than what the company initially paid for it.

Accumulated depreciation is neither an asset nor a liability. Instead, it gets recorded as a credit balance in the accumulated depreciation account, a contra asset account. As a contra asset, accumulated depreciation offsets the value of the asset.

Accumulated depreciation represents the total amount of depreciation of an asset up to a given point. A depreciation expense refers to the amount of depreciation recorded on a company's balance sheet for a single accounting period. If you were to add up all the depreciation expenses for a capital asset over the course of ownership, the total amount would represent its accumulated depreciation.

Under standard accounting practices, accumulated depreciation is a contra asset that should appear on a company’s balance sheet. Meanwhile, regular depreciation expenses should be debited from income statements.

The easiest way to calculate accumulated depreciation using the straight-line depreciation method. The straight-line method involves a few simple inputs and a straightforward formula for calculating depreciation.

1. 1. Begin with the initial cost of the asset. Start your straight-line depreciation calculation by noting the purchase price of your capital asset.
2. 2. Determine the salvage value of the asset. The salvage value—also called the residual value—is the amount of money you could reasonably expect to receive at the end of an asset’s useful life. For tangible assets like cars and computers, this might be the total amount of money you could get if you sold those items for parts.
3. 3. Subtract the salvage value from the original cost of the asset. The difference between these amounts represents the total accumulated depreciation you can claim over the life of the asset.
4. 4. Divide the total depreciation amount by the number of years you expect to hold the capital asset. This quotient will give you the annual depreciation amount for each year you own the asset. The first year and the final year of ownership will both show the same amount of depreciation.
5. 5. Calculate the accumulated depreciation at a given point in time. Once you have the annual depreciation expense, you can calculate depreciation as it accumulates over time. For example, after one year of owning and operating a piece of equipment, the annual depreciation expense and the accumulated depreciation are the same. With each additional year of use, the accumulated depreciation amount grows while the annual depreciation amount stays the same.

Under generally accepted accounting principles (GAAP), annual depreciation expenses should be reflected in a contra asset account on a company balance sheet. Contra accounts work in the opposite direction of related accounts on cash flow statements. This accounting concept applies to accumulated depreciation because a company may be simultaneously buying a capital asset using installment payments—in a process called amortization—while also reporting a declining asset value thanks to depreciation.

For a simple example of accumulated depreciation, imagine that a trucking company purchases a new truck that it intends to use for twenty years. The purchase price of the hypothetical truck is $150,000. The estimated salvage value of the truck after ten years will be $35,000.

Using the straight-line method of depreciation, the company determines the truck will depreciate by $115,000 over ten years.

$150,000 - $35,000 = $115,000

By dividing $115,000 by ten, the company can determine an annual depreciation expense of $11,500.

$115,000 ÷ 10 = $11,500

If the company wanted to know the truck’s accumulated depreciation amount after operating it consistently for three years, it would multiply $11,500 by three and get $34,500. To calculate the accumulated depreciation amount on a quarterly basis, the company would divide $11,500 by four to arrive at a quarterly depreciation expense of $2,875. Here’s how this would look over the lifetime of the asset:

Accelerated depreciation methods follow the idea that depreciation rates tend to be steeper in the early years of ownership. The benefit is a greater tax write-off in the short term because the carrying value of an asset rapidly declines in the first few years after it is purchased. The drawback is that toward the end of the asset’s useful life, the asset’s net book value changes very little as most of the tax benefits have already been exhausted. Accelerated depreciation methods include:

1. 1. Declining balance method: This accelerated method involves multiplying the current book value (CBV) of the asset by the depreciation rate (a percentage).
2. 2. Double-declining balance (DBB) method: The double-declining balance method depreciates assets twice as fast as the declining balance method. To use it, first multiply the CBV by the depreciation rate, then double it.
3. 3. “Sum of the years’ digits” method: This method involves adding together the digits of each year of an asset’s life. For example, the sum of the years’ digits for a 10-year asset would be 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 = 55. In year one, you’ll divide the highest number (10) by the sum (55) to determine the depreciation rate for that year (18%). In year two, you’ll divide the second-highest number (9) by the sum (55) to get the next depreciation rate (16%). The depreciation rate will slowly decline over time.

Get the MasterClass Annual Membership for exclusive access to video lessons taught by business luminaries, including Sara Blakely, Chris Voss, Robin Roberts, Bob Iger, Howard Schultz, Anna Wintour, and more.