Accumulated depreciation refers to the aggregate amount of depreciation expense occurred since the fixed assets were placed on the company’s books.
Accumulated depreciation is a contra asset account because it reduces the carrying value of the underlying asset.
For an example of accumulated depreciation, consider the following scenario. A company purchases a vehicle for $50,000. The vehicle’s estimated useful life is 5 years, and the estimated residual value is $10,000. For simplicity, we’ll assume the asset is acquired on Jan. 1, and that the company uses a calendar year for reporting purposes.
The annual depreciation rate in the above scenario is 20%, since each year 1/5th of the asset is depreciated. The asset’s depreciable base is $40,000. The depreciable base is calculated by subtracting the residual value from the asset’s acquisition cost.
Each year the company recognizes $8,000 of depreciation expense on the asset. The year-end journal entry is as follows:
Debit depreciation expense by $8,000 ; Credit accumulated depreciation by $8,000.
Accumulated depreciation increases each year by the amount of depreciation expense for the year. So, accumulated depreciation is $8,000 in year 1, $16,000 in year 2, $24,000 in year 3, etc.
Accumulated depreciation is an important factor in determining the gain or loss on the sale of an asset. If the sale amount exceeds the asset’s carrying amount (cost minus accumulated depreciation), the company recognizes a gain. If the carrying amount exceeds the sale price, the company recognizes a loss.
