What is accumulated depreciation? And why does it matter to my business?
So you’ve invested in assets for your business, but as time passes, their value declines. Did you know that this is actually an accounting concept that impacts your bottom line? Accumulated depreciation is more than a mere reduction in numbers; it’s one factor that shapes your company’s financial landscape. In this guide, we’ll dissect the calculation method for accumulated depreciation, pinpoint where it is in financial statements, and explore why it should be tracked as part of any business’s fiscal health.
What is accumulated depreciation?
Accumulated depreciation is the total amount of depreciation expense that has been recorded against a company’s assets over time. It is a key indicator of an asset’s wear and tear, usage, or obsolescence as it approaches the end of its useful life. Not only is it of the utmost importance for accurately reporting a company’s value, but it’s also vital for tax and investment considerations. As it accumulates, business owners and financial analysts can gauge how much an asset’s initial cost has been accounted for in terms of depreciation.
How do you calculate accumulated depreciation?
When it comes to calculating accumulated depreciation, several methods are available, each with its own rhyme and reason depending on the nature of the asset and how it’s being used over time. If you’re a solopreneur or small business owner, then knowing how to calculate this figure is essential when it comes to making informed decisions about things like purchasing new office furniture or equipment.
The Straight-Line Method
One common method of calculating accumulated depreciation is the Straight-Line Method, where the same amount of depreciation is allocated each year over the asset’s useful life. For example, if you bought a $2,000 computer for your home office with a 4-year useful life and a $200 salvage value (its worth if it were to be sold at the end of its useful life), it would be depreciated at $450 per year (($2,000 - $200) / 4 years).
The Double-Declining Balance Method
The Double-Declining Balance Method accelerates depreciation in the earlier years of an asset’s life. It doubles the straight-line depreciation rate and applies it to the asset’s remaining book value at the beginning of each year, initially resulting in a higher depreciation expense that decreases over time.
The Units of Production Method
The Units of Production Method ties the depreciation expense to the actual usage of the asset. Let’s say a company’s printer is anticipated to print 100,000 pages over its life and will print 10,000 a year. That means 10% of the printer’s cost minus salvage value will be depreciated that year.
The Modified Accelerated Cost Recovery System (MACRS)
The Modified Accelerated Cost Recovery System (MACRS) is the tax depreciation system used in the U.S. MACRS includes different classes and recovery periods for different types of assets, allowing for larger depreciation deductions in the first few years after an asset is placed in service.
How do you find accumulated depreciation?
To find accumulated depreciation, add all depreciation expenses recorded for an asset since its acquisition. This includes the yearly depreciation and any additional depreciation resulting from asset impairment or revisions of its useful life.
Where does accumulated depreciation go on a balance sheet? Is accumulated depreciation an asset?
Typically, accumulated depreciation is listed below the related fixed assets in a section referred to as “property, plant, and equipment.” It’s not an asset but is considered to be a contra-asset account. This means it carries a balance and is deducted from the total value of the assets it relates to.
Here’s a simplified example of how it might appear on a balance sheet:
| Assets | |
| Current assets | Amount (in dollars) |
| (e.g., cash, inventory) | |
| Total current assets | X |
| Property, plant, & equipment | |
| Machinery | 50,000 |
| Office equipment | 20,000 |
| Buildings | 100,000 |
| Less: accumulated depreciation | (45,000) |
| Net property, plant, & equipment | 125,000 |
| Total assets | Total of all assets |
In the table, the accumulated depreciation of $45,000 reduces the total value of the property, plant, and equipment from $170,000 to $125,000. This adjusted value, called the “net book value,” reflects a more accurate representation of the assets’ worth in terms of their age and usage.
Why is it important to track accumulated depreciation?
Accurate depreciation tracking means that financial statements present a fair picture of the company’s worth, thus influencing the strategic planning and valuation of the business. From a tax perspective, meticulously recording depreciation helps ensure compliance with tax regulations and can lead to potential tax benefits.
Here’s how accumulated depreciation can impact your financial reporting:
On the balance sheet:
Assets: lowers the value of fixed assets over time.
Equity: indirectly affects retained earnings through net income.
On the income statement:
Expenses: depreciation expense is recorded, affecting net income.
For tax purposes:
It provides a basis for tax deductions on asset depreciation.
For asset valuation:
It reflects a more accurate value of business assets, which is crucial for investors.
How to calculate and record accumulated depreciation
Calculating and recording accumulated depreciation is a straightforward process, yet requires attention to detail to ensure accuracy. Here’s a walkthrough of some essential steps you can use to calculate it:
1. Gather all the information needed to calculate accumulated depreciation.
Asset cost: The asset cost is the original price of the asset.
Salvage value: The salvage value is what the asset will be worth at the end of its life – usually a small number.
Useful life: The useful life estimates how long the asset will be used by the business (number of years). The IRS is a great resource for the typical useful lives of various assets.
2. Choose a depreciation method that works best for your business.
The straight-line method is typically considered the simplest and most common for small businesses.
3. Calculate annual depreciation using the accumulated depreciation formula.
Formula: Annual Depreciation Expense = (Asset Cost - Salvage Value) / Useful Life
4. Track accumulated depreciation when tracking your business expenses.
In the first year: Start with zero accumulated depreciation.
Then, in the years following the first year: Add the annual depreciation expense you calculated using the formula in the third step to the previous year's accumulated depreciation. You’ll get the total accumulated depreciation number for that year.
5. Recording accumulated depreciation.
You don't need a complex system when recording accumulated depreciation for your business. Using a simple spreadsheet can track your assets, the details of your assets, and the annual calculated depreciation. However, using accounting or expense software tracking to automate your depreciation calculations and other business expenses is really the best solution to avoid making any mistakes.
Tips for recording and maintaining accurate accumulated depreciation records
Here are some best practices for when it comes to recording and maintaining accurate accumulated depreciation records:
Track, track, track: Whatever method you use to keep track of your stuff, keep an up-to-date list of all your business equipment like furniture, computers, hardware, etc., along with their purchase price. This is where Expensify can come in handy. Protip: Ensure you have a category to group your depreciable assets so you can pull them up easily in the future!
Life expectancy: Estimate how long your items will be “useful.” Typically, most things will be in the three- to five-year range.
Do the math: Your yearly depreciation expense is calculated by dividing the cost (minus scrap value) by the number of useful years.
Keep track (again): Every year, keep track of your accumulated depreciation by adding the depreciation expense you calculated to a running total. Do this for every item.
Keep a paper trail: Be sure to hold onto receipts and have your depreciation list somewhere that’s safe and secure. Physical backups are good, but keeping digital receipt backups is even better, so you never have to worry about making sure those little pieces of paper stay legible.
Expensify can help you track and manage your expenses
Don’t guess or get overwhelmed with manually tracking and managing your expenses. Let Expensify help you automate your expense management and financial transactions. Seamlessly categorize your assets and never miss a beat regarding accumulated depreciation.
FAQs about accumulated depreciation
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Accumulated depreciation is a contra-asset account used in accounting. Unlike typical asset accounts, which carry a debit balance, a contra-asset account has a credit balance. It appears on the balance sheet paired with the asset it’s associated with, offsetting the balance of the associated asset account, reducing the gross amount to get the net book value.
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Accumulated depreciation is a credit balance. When accounting for depreciation, an entry is made that debits the depreciation expense and credits the accumulated depreciation account. So, with each depreciation expense recorded, the accumulated depreciation account grows in value, hence the reason for a credit balance.
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The formula for calculating accumulated depreciation varies depending on the method used. One of the most common methods is the Straight-Line Method, which is the easiest. Here’s the formula:
Accumulated Depreciation = (Cost of Asset - Salvage Value) x (Number of years the asset has been in use / Estimated useful life)
The asset's cost is the initial purchase price, the salvage value is the estimated resale value at the end of its useful life, and the estimated useful life is the time period expected for the asset to be used in the business. Each year, the specified depreciation expense is added to the accumulated depreciation account, and the remaining book value of the asset decreases accordingly.
Ready to track your business expenses and accumulated depreciation with ease? Give Expensify a try today by filling out the form below; we’ll take it from there.
