DEPRECIATION RESERVE

Depreciation reserves are funds established by a business for expensive items that depreciate
overtime and must be replaced. The business puts money into the reserve every year
according to the amount the item depreciates and its salvage value. This allows the business
to have the funds available to replace expensive equipment as it must be replaced. Many
businesses have equipment that is essential to their operation but can cost much more than the
businesses can afford in a single year. Depreciation reserves allows the business to slowly
prep for the cost and do so in a way that avoids taxes

ACCUMULATED DEPRECIATION

Table of Contents
 What Is Accumulated Depreciation?
 Understanding Accumulated Depreciation
 Calculating Accumulated Depreciation
 Accumulated vs. Accelerated
 Accumulated vs. Expense
 Special Considerations
 Example
 Accumulated Depreciation FAQs
 The Bottom Line

What Is Accumulated Depreciation?

Accumulated depreciation is the cumulative depreciation of an asset up to a single point in its
life. Accumulated depreciation is a contra asset account, meaning its natural balance is a
credit that reduces the overall asset value.

KEY TAKEAWAYS
 Depreciation is recorded to tie the cost of using a long-term capital asset with the
benefit gained from its use over time.
 Accumulated depreciation is the sum of all recorded depreciation on an asset to a
specific date.
 Accumulated depreciation is presented on the balance sheet just below the related
capital asset line.
 Accumulated depreciation is recorded as a contra asset that has a natural credit
balance (as oppose to asset accounts with natural debit balances).
 The carrying value of an asset is its historical cost minus accumulated depreciation.
Understanding Accumulated Depreciation
The matching principle under generally accepted accounting principles (GAAP) dictates that
expenses must be matched to the same accounting period in which the related revenue is
generated. Through depreciation, a business will expense a portion of a capital asset's value
over each year of its useful life. This means that each year a capitalized asset is put to use and
generates revenue, the cost associated with using up the asset is recorded.

Accumulated depreciation is the total amount an asset has been depreciated up until a single
point. Each period, the depreciation expense recorded in that period is added to the beginning
accumulated depreciation balance. An asset's carrying value on the balance sheet is the
difference between its historical cost and accumulated depreciation. At the end of an asset's
useful life, its carrying value on the balance sheet will match its salvage value.

When recording depreciation in the general ledger, a company debits depreciation expense
and credits accumulated depreciation. Depreciation expense flows through to the income
statement in the period it is recorded. Accumulated depreciation is presented on the balance
sheet below the line for related capitalized assets. The accumulated depreciation balance
increases over time, adding the amount of depreciation expense recorded in the current
period.

Fast Fact -
Accumulated depreciation is dependent on salvage value; salvage value is determined as the
amount a company may expect to receive in exchange for selling an asset at the end of its
useful life.

How to Calculate Accumulated Depreciation

There are several acceptable methods for calculating depreciation. These methods are
allowable under Generally Accepted Accounting Principles (GAAP). A company may select
the depreciation method they wish to use.

 Straight-Line Method :-
Under the straight-line method of accounting, a company deducts the asset’s salvage
value from the purchase price to find a depreciable base. Then, this base is accumulated
evenly over the anticipated useful life of the asset. The straight-line method formula is:

Annual Accumulated Depreciation = (Asset Value – Salvage Value) / Useful Life in

Years
 Declining Balance Method :-
Under the declining balance method, depreciation is recorded as a percentage of the
asset’s current book value. Because the same percentage is used in every year while the
current book value decreases, the amount of depreciation decreases each year. Even
though accumulated depreciation will still increase, the amount of accumulated
depreciation will decrease each year.

Annual Accumulated Depreciation = Current Book Value * Depreciation Rate

 Double-Declining Balance Method:-

Under the double-declining balance (also called accelerated depreciation), a company
calculates what it’s depreciation would be under the straight-line method. Then, the
company doubles the depreciation rate, keeps this rate the same across all years the
asset is depreciated, and continues to accumulate depreciation until the salvage value is
reached. The percentage can simply be calculated as twice of 100% divided by the
number of years of useful life.

Double-Declining Balance Method Rate = (100% / Useful Life In Years) * 2

Double-Declining Balance Method = Depreciable Amount * Double-Declining Balance

Method Rate

 Sum-of-the-Years’ Digits Method :-

Under the sum-of-the-years' digits method, a company strives to record more
depreciation earlier in the life of an asset and less in the later years. This is done by
adding up the digits of the useful years, then depreciating based on that number of year.

Annual Accumulated Depreciation = Depreciable Base * (Inverse Year Number / Sum

of Year Digits)

 Units of Production Method :-

Under the units of production method, a company estimates the total useful output of an
asset. Then, the company evaluates how many of those units were consumed each year
to recognize accumulated depreciation variably based on use. The formula for the units
of production method is:
 Annual Accumulated Deprecation = (Number of Units Consumed / Total Units To Be
Consumed) * Depreciable Base

ACCUMULATED DEPRECIATION VS. ACCELERATED

DEPRECIATION
Though similar sounding in name, accumulated depreciation and accelerated depreciation
refer to very different accounting concepts. Accumulated depreciation refers to the life-to-
date depreciation that has been recognized that reduces the book value of an asset. On the
other hand, accelerated depreciation refers to a method of depreciation where a higher
amount of depreciation is recognized earlier in an asset’s life.

Since accelerated depreciation is an accounting method for recognizing depreciation, the

result of accelerated depreciation is to book accumulated depreciation. Under this method, the
amount of accumulated depreciation accumulates faster during the early years of an asset’s
life and accumulates slower later. The philosophy behind accelerated depreciation is assets
that are newer (i.e. a new company vehicle) are often used more than older assets because
they are in better condition and more efficient.

Important -
Accumulated depreciation is a real account (a general ledger account that is not listed on the
income statement). The balance rolls year-over-year, while nominal accounts like
depreciation expense are closed out at year end.

Accumulated Depreciation vs. Depreciation Expense

When an asset is depreciated, two accounts are immediately impacted: accumulated
depreciation and depreciation expense. The journal entry to record depreciation results in a
debit to depreciation expense and a credit to accumulated depreciation. The dollar amount for
each line is equal to the other.

There are two main differences between accumulated depreciation and depreciation expense.
First, depreciation expense is reported on the income statement, while accumulated
depreciation is reported on the balance sheet.

Second, on a related note, the income statement does not carry from year-to-year. Activity is
swept to retained earnings, and a company “resets” its income statement every year.
Meanwhile, its balance sheet is a life-to-date running total that does not clear at year-end.
Therefore, depreciation expense is recalculated every year, while accumulated depreciation is
always a life-to-date running total.

SPECIAL CONSIDERATIONS
Accounting Adjustments/Changes in Estimate
Because the depreciation process is heavily rooted with estimates, it’s common for companies
to need to revise their guess on the useful life of an asset’s life or the salvage value at the end
of the asset’s life. This change is reflected as a change in accounting estimate, not a change in
accounting principle.

Half-Year Recognition
A commonly practiced strategy for depreciating an asset is to recognize a half year of
depreciation in the year an asset is acquired and a half year of depreciation in the last year of
an asset’s useful life. This strategy is employed to more fairly allocate depreciation expense
and accumulated depreciation in years when an asset may only be used part of a year.

Accumulated Depreciation FAQ

 Is Accumulated Depreciation an Asset?

Accumulated depreciation is a contra asset that reduces the book value of an asset.
Accumulated depreciation has a natural credit balance (as opposed to assets that have
a natural debit balance). However, accumulated depreciation is reported within the
asset section of a balance sheet.

 Is Accumulated Depreciation a Current Liability?

Accumulated depreciation is not a liability. A liability is a future financial obligation
(i.e. debt) that the company has to pay. Accumulation depreciation is not a cash
outlay; the cash obligation has already been satisfied when the asset is purchased or
financed. Instead, accumulated depreciation is the way of recognizing depreciation
over the life of the asset instead of recognizing the expense all at once.

 How Do You Calculate Accumulated Depreciation?

Accumulated depreciation is calculated using several different accounting methods.
Those accounting methods include the straight-line method, the declining balance
method, the double-declining balance method, the units of production method, or the
sum-of-the-years method. In general, accumulated depreciation is calculated by taking
the depreciable base of an asset and dividing it by a suitable divisor such as years of
use or units of production.

 Where Is Accumulated Depreciation Recorded?

 Accumulated depreciation is recorded as a contra asset via the credit portion of a
journal entry. Accumulated depreciation is nested under the long-term assets section
of a balance sheet and reduces the net book value of a capital asset.

 Is Accumulated Depreciation a Credit or Debit?

Accumulated depreciation is a natural credit balance. Although it is reported on the
balance sheet under the asset section, accumulated depreciation reduces the total value
of assets recognized on the financial statement since assets are natural debit accounts.

THE BOTTOM LINE :-

Many companies rely on capital assets such as buildings, vehicles, equipment, and machinery
as part of their operations. In accordance with accounting rules, companies must depreciate
these assets over their useful lives. As a result, companies must recognize accumulated
depreciation, the sum of depreciation expense recognized over the life of an asset.
Accumulated depreciation is reported on the balance sheet as a contra asset that reduces the
net book value of the capital asset section.