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Accumulated Depreciation Definition
Accumulated Depreciation is the entire portion of the cost of an asset allocated to depreciation expense since the time an asset is put into service. It is associated with assets like machinery, buildings, vehicles office furniture among others.
This concept of accumulated depreciation is used in the world of financial accounting where the term ‘cumulative’ is used to express the time taken to depreciate an asset.
A Little More on What is Accumulated Depreciation
Assets and goods record a decrease in value over time for accounting purposes. This is known as depreciation. When this value is accrued over the years of the asset’s useful life, accumulated depreciation is obtained.
Therefore accumulated depreciation refers to the time an asset takes to depreciate. It is an account in which the declining value of the asset accumulates as time passes until the asset is fully depreciated, removed from the inventory list, or sold.
The account created for accumulated depreciation is a compensatory one which decreases the fixed assets account. Unlike other accounts, this one continues to increase until after the asset has been written off, sold, or fully depreciated. It is therefore not closed at the end of the accounting period.
When an asset is purchased, the average useful life (period in which it will be used in business) is calculated. Then the annual or monthly depreciation amount is determined using depreciation methods. The cumulative depreciation value must be in tandem with the original price of the asset.
Using the Accumulated Depreciation Method
This method involves the calculation of the annual amount by which the asset is depreciated and then making subsequent summation until the amount corresponds to the original of the depreciated asset.
This method can be applied to any asset such as vehicles, plants, and machinery. However, land and real estate are not subjected to depreciation.
Depreciation is adjusted through inflation following the existing laws.
Each asset has a determined useful lifespan. For example, a computer is considered to have a useful life of 5 years while a machine is deemed to have a useful life of 10 years. According to this, the computer will have a 20% annual depreciation while the machine will have one of 10%.
Depreciation, in theory, comes from the wear and tear that an asset gets throughout its use over time. This does not mean, however, that when you buy an asset and don’t use it over time, it will have the same value.
Even if you do not use the asset, a measure of annual depreciation for that asset will still be recorded for accounting purposes in recognized depreciation tables.
These depreciation tables are used to show the depreciation of generic assets such as goods from the construction industry, buildings, extractive industry, transport companies, telecommunications, and many others
Accounting for Accumulated Depreciation
A debit for depreciation expenses and credit for accrued depreciation are recorded every month in the general ledger.
Debit depreciation expenses represent the margin of the net income while accrued credit depreciation serves to control a balanced account.
The depreciation class includes an asset account which appears as an asset in the balance sheet, and therefore it maintains a positive balance.
This depreciation class is under assets subject to depreciation, and it shows in the balance sheet as the net depreciable asset together with the depreciation sum account.
The difference in the balance of this type of depreciation and the depreciation expense of a depreciable asset is because the second one shows the depreciation for the period while the first one shows all the depreciation amount calculated since the company acquired the asset.
Examples of Useful Life
- Real estate (including oil pipelines): 20 years
- Ships, trains, aircraft, machinery, equipment and personal property: 10 years
- Automotive vehicles and computers: 5 years
In real estate, the amount related to land and construction is ignored unless stated otherwise by an expert. Since depreciation relies on the estimated useful life of the property, the use or a decrease in demand is considered. This ensures that it’s possible to calculate depreciation on the estimated useful life of each asset.
One of the reasons that companies record depreciation is because they can deduct the expenses legally accepted. It enables the companies to replace equipment or recondition it. The companies are advised to form a reserve fund through the depreciation records which allow them to replace an asset once its useful life is over.
References for Accumulated Depreciation
Academic Research on Accumulated Depreciation
- Conservatism in accounting part II: Evidence and research opportunities, Watts, R. L. (2003), Accounting horizons, 17(4), 287-301. This paper essentially summarizes the empirical evidence available on the existence of conservatism, the conservatism’s increase over time and also the conservatism’s alternative explanations. It does not fail to even discuss whether there are opportunities for future research on conservatism.
- Depreciation and fixed asset valuation in British railway company accounts to 1911, Edwards, J. R. (1986), Accounting and Business Research, 16(63), 251-263. This paper investigates how the fixed assets are treated under the double account system and if the 1868 Act might have affected how railway managers reported these items.
- Accounting for accountability and management in NPOs. A comparative study of four countries: Canada, the United Kingdom, the USA and Spain, Torres, L., & Pina, V. (2003), Financial Accountability & Management, 19(3), 265-285. This study discusses financial and non-financial information as developing issues in the NPO field. It also acknowledges the fact that most developed countries have managed to update their accounting systems for NPOs by implementing full accrual basis to enhance their accountability and also the usefulness of accounting information when making decisions.
- From cash to accrual budgeting and accounting in the public sector: The Dutch experience, Peter Van Der Hoek, M. (2005), Public Budgeting & Finance, 25(1), 32-45. This paper studies how most countries are transitioning accounting in their public sectors from cash-based to accrual-based. It focuses on the experiences of the Dutch when they shifted from cash-based to accrual-based systems.
- The measurement of meaning in accounting: A critical analysis of the principal evidence, Houghton, K. A. (1988), Accounting, Organizations and Society, 13(3), 263-280. This paper argues that for the preparers of accounting information and the end users to effectively communicate, there must be a sharing of meaning between these parties.
- Capital assets in governmental accounting reforms: comparing Flemish technical issues with international standards, Christiaens*, J. (2004), European Accounting Review, 13(4), 743-770. This paper presents an overview of the different accounting standards concerning government capital assets. It then analyses the criteria of recognition, valuation, together with the disclosure of capital assets in the reforms of three Flemish governments.
- Illustrations of the early treatment of depreciation, Mason, P. (1933), Accounting Review, 209-218. This study explains using illustrations on how depreciation used to be treated before the current methods were adopted.
- The role of accounting conservatism in mitigating bondholder-shareholder conflicts over dividend policy and in reducing debt costs, Ahmed, A. S., Billings, B. K., Morton, R. M., & Stanford-Harris, M. (2002), The Accounting Review, 77(4), 867-890. This article uses an accrual-based and market-based measure of conservatism to investigate whether the firms that face more severe conflicts when it comes to dividend policy tend to us more conservative accounting.
- Cash flow is a fact. Net income is just an opinion, Fernandez, P. (2004), In descargable en http://ssrn. com/abstract (Vol. 330540). This paper investigates the use of three different cash flows which are equity cash flow, free cash flow, and capital cash flow to answer the question ‘when net income is equal to the equity cash flow, what then?’
- Accounting for asset retirement obligations, Alexander, E. R., & Hiner, R. R. (2001), Journal of Accountancy, 192(6), 49. This paper investigates the accounting for the retirement of assets that are long-lived and depending on future events out of the control of the obligated party.