Is Depreciation a Fixed Asset? An Accounting Answer

When exploring a company’s financial health, two terms frequently appear: fixed assets and depreciation. These concepts are often misunderstood, leading to questions like whether depreciation itself is a fixed asset. Depreciation is not a fixed asset. This article clarifies what each term means and explains their distinct, yet interconnected, roles in accounting.

What is a Fixed Asset?

A fixed asset represents a long-term tangible item a company owns and uses to generate income. These assets are not intended for sale in the ordinary course of business but rather support the company’s operations over an extended period, typically more than one accounting period. Fixed assets are also known as property, plant, and equipment (PP&E) on a company’s financial statements.

These assets possess a physical form, unlike intangible assets such as patents or trademarks. Common examples include land, buildings, machinery, equipment, vehicles, and furniture. They are recorded on a company’s balance sheet under the noncurrent asset section. Fixed assets are generally acquired at a substantial initial cost.

What is Depreciation?

Depreciation is an accounting method used to systematically allocate the cost of a tangible asset over its useful life. Its primary purpose is to match the expense of using an asset with the revenue it helps generate over time. This process reflects the consumption of an asset’s economic benefits, recognizing that assets gradually lose value due to wear and tear, obsolescence, or usage.

Depreciation is recorded as an expense on a company’s income statement. It is a non-cash expense, meaning it does not involve an actual outflow of cash. Factors considered when calculating depreciation include the asset’s original cost, its estimated salvage value, and its estimated useful life.

The Relationship Between Depreciation and Fixed Assets

While depreciation is directly applied to fixed assets, it is not a fixed asset itself. Fixed assets are the physical items a business owns and utilizes for its operations, while depreciation is the accounting process of expensing their cost over their useful life.

Depreciation systematically reduces the book value of a fixed asset on the balance sheet. This reduction is achieved through an account called “accumulated depreciation,” which is a contra-asset account. Accumulated depreciation acts as an offset to the original cost of the fixed asset, showing its net carrying value.

For instance, consider a company truck. The truck itself is the fixed asset. As the truck is used, a portion of its cost is expensed each accounting period through depreciation, lowering its reported value on the balance sheet.

Impact on Financial Statements

Depreciation impacts a company’s financial statements, affecting both the balance sheet and the income statement. On the balance sheet, accumulated depreciation is presented as a deduction from the original cost of fixed assets, reducing the asset’s carrying value.

On the income statement, depreciation is recorded as an operating expense. This expense reduces a company’s reported net income. Although depreciation reduces net income, it is a non-cash expense. For this reason, depreciation is added back to net income in the operating activities section when preparing the cash flow statement using the indirect method.