Accumulated Depreciation also refers to of the contra-asset on the balance sheet which is used when depreciation expense is documented after a passage of time in each period of accounting. A fixed asset is purchased for $100,000 and used for 5 years. When the fixed asset was bought, it was recorded in the balance sheet with its full value. When it was started to be used assuming straight line depreciation was used with a residual value of 0, a cost of $20,000 was booked per years as a debit in the profit and loss statement and the offset of that journal entry was a credit to balance sheet account called accumulated depreciation.
In order to find the book value or carrying value of the fixed asset at the end of year 1, you sum together the historical cost of the fixed asset on the balance sheet and the accumulated depreciation on the balance sheet which is:
100,000-20,000 = $80,000 is the Net Book Value
This information is recorded into two separate accounts as you want to preserve the information about what you originally purchased and how much you spent on that asset and what you have depreciated with the passage of time. In year 2, you repeat the same depreciation journal entry and get to a book value of $60,000 and also for year 3, 4, and 5.
Accumulated Depreciation Explanation
The difference between depreciation expense and accumulated depreciation is that the depreciation expense appears as an expense on the profit and loss statement while the accumulated depreciation is a contra-asset which is reported on the balance sheet. The profit and loss statement is set to 0 at the start of every year so you start with 0 in depreciation expense in every year and build it up in 12 months increments. The accumulated depreciation amount in the balance sheet keeps increasing over the years all the way to the point at which the fixed asset is fully depreciated or the point where you sell the fixed asset at above or below the book value.
Methods to Evaluated Accumulated Depreciation
Following are some of the methods through which accumulated depreciation can be evaluated:
- Calculating the price of the asset along with any cost related to the asset while purchasing it such as transportation, warehousing, etc.
- Estimating the selling value of the asset after its useful life is completed
- Subtracting the selling value from any cost related to the purchase of the asset.
- Finding out the useful life of the asset.
- Dividing the depreciated value from the useful life of the asset.
- Multiply the annual depreciated value with the amount of time that the business has used the asset for.
Mukharji, A., & Hanif, M. (2003). Financial Accounting (Vol. 1). New Delhi: Tata McGraw-Hill Publishing Co.
Narayanswami, R. (2008). Financial Accounting: A Managerial Perspective. (3rd, Ed.) New Delhi: Prentice Hall of India.
Ramchandran, N., & Kakani, R. K. (2007). Financial Accounting for Management. (2nd, Ed.) New Delhi: Tata McGraw Hill.