How to Record Accumulated Depreciation

Depreciation is an accounting method that systematically allocates the cost of a tangible asset over its useful life. This process reflects the gradual decrease in an asset’s value due to wear and tear, obsolescence, or usage. Accumulated depreciation represents the total depreciation expense charged against an asset since it was first put into service.

Recognizing depreciation and accumulated depreciation aligns with the matching principle of accounting. This principle dictates that expenses should be recognized in the same period as the revenues they help generate. By spreading an asset’s cost over its useful life, depreciation matches the expense of using the asset with the revenue it helps produce, providing a more accurate picture of a company’s financial performance and a realistic valuation of its assets.

Understanding Depreciation Expense

Accumulated depreciation is the sum of all periodic depreciation expenses recorded for an asset. Businesses commonly use several methods to determine this amount, each allocating the asset’s cost over its useful life differently.

Straight-Line Method

The Straight-Line method is the simplest and most widely used approach, distributing an equal amount of depreciation expense to each period over the asset’s useful life. To calculate straight-line depreciation, subtract the asset’s estimated salvage value (expected value at the end of its useful life) from its original cost, then divide that amount by the asset’s useful life in years. For example, if a machine costs $10,000, has a salvage value of $1,000, and a useful life of 5 years, the annual depreciation would be ($10,000 – $1,000) / 5 years = $1,800 per year.

Double-Declining Balance Method

The Double-Declining Balance method is an accelerated depreciation technique, recognizing more depreciation expense in the earlier years of an asset’s life. This method is suitable for assets that lose value quickly or are more productive initially. The calculation involves doubling the straight-line depreciation rate and applying it to the asset’s book value (cost minus accumulated depreciation) at the beginning of each period. For instance, if an asset has a 10-year useful life, the straight-line rate is 10% (1/10 years), so the double-declining balance rate would be 20%. If an asset costs $100,000 with no salvage value, the first year’s depreciation would be $100,000 x 20% = $20,000. The following year, the book value would be $80,000 ($100,000 – $20,000), and the depreciation would be $80,000 x 20% = $16,000.

Units of Production Method

The Units of Production method depreciates an asset based on its actual usage or output. This method is useful for assets whose wear and tear are directly tied to their activity level, such as machinery or vehicles. To calculate depreciation, determine the depreciation cost per unit by subtracting the salvage value from the asset’s cost and dividing it by the total estimated units the asset is expected to produce. Then, multiply this per-unit cost by the number of units produced in the current period. For example, if a machine costs $3,000, has a salvage value of $500, and is expected to produce 5,000 units, the depreciation per unit is ($3,000 – $500) / 5,000 units = $0.50 per unit. If the machine produces 1,200 units in a year, the depreciation expense for that year would be 1,200 units x $0.50/unit = $600.

Recording Accumulated Depreciation

The accumulated depreciation account is a contra-asset account, meaning it reduces the reported value of an asset on the balance sheet. While most asset accounts have a debit balance, contra-asset accounts like accumulated depreciation have a natural credit balance, which increases with each depreciation entry.

The standard journal entry to record periodic depreciation involves two accounts: Depreciation Expense and Accumulated Depreciation. At the end of each accounting period, typically monthly or annually, the Depreciation Expense account is debited, and the Accumulated Depreciation account is credited. This entry increases the Depreciation Expense on the income statement and increases the total accumulated depreciation on the balance sheet.

For instance, using the straight-line example where annual depreciation is $1,800, the journal entry would be: Debit Depreciation Expense $1,800 and Credit Accumulated Depreciation $1,800. If this were the first year of the asset’s life, the accumulated depreciation balance would be $1,800.

Considering the double-declining balance example, where the first year’s depreciation was $20,000, the journal entry would be: Debit Depreciation Expense $20,000 and Credit Accumulated Depreciation $20,000. In the second year, with a depreciation expense of $16,000, the entry would be: Debit Depreciation Expense $16,000 and Credit Accumulated Depreciation $16,000. After the second year, the accumulated depreciation balance would be $36,000 ($20,000 + $16,000).

For the units of production method, if the depreciation expense for the year was $600, the entry would be: Debit Depreciation Expense $600 and Credit Accumulated Depreciation $600. The accumulated depreciation balance continues to grow until it equals the asset’s depreciable cost (cost minus salvage value), at which point the asset is considered fully depreciated.

Presenting Accumulated Depreciation on Financial Statements

Accumulated depreciation primarily appears on the balance sheet, which provides a snapshot of a company’s assets, liabilities, and equity at a specific point in time. On the balance sheet, accumulated depreciation is typically presented directly below the related tangible asset, such as property, plant, and equipment (PP&E).

The original cost of the asset is shown, and then accumulated depreciation is subtracted from this cost to arrive at the asset’s net book value or carrying value. For example, if a piece of machinery was purchased for $50,000 and has accumulated depreciation of $10,000, it would be presented on the balance sheet as: Machinery (at cost) $50,000, Less: Accumulated Depreciation $10,000, resulting in a Net Book Value of $40,000.

The Depreciation Expense, the amount of depreciation recognized for a single accounting period, is reported separately on the income statement. It is typically found within the operating expenses section, or it may be included as part of the cost of goods sold, depending on the asset’s use. This expense reduces the company’s net income for the period, reflecting the cost of using the asset to generate revenue.