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Accumulated depreciation is the total amount of depreciation of a company asset, such as a computer or company vehicle. It shows much value a particular asset has lost since your company initially put it into service.Accumulated depreciation is related to – but not the same as – a depreciation expense. A depreciation expense is the cost of an asset that has been depreciated for a certain period, say one year, and shows how much of the asset's value has been used up in that year.Read on for a closer look at what accumulated depreciation means, why it's an important number for your small business to know, and how to calculate an asset’s accumulated depreciation.
What Is Accumulated Depreciation?
Accumulated depreciation is the total amount of depreciation that has occurred for a tangible asset.Many business assets – including manufacturing machinery, vehicles, equipment, computers, and buildings – can lose their value over time. Accumulated depreciation is all of the value that has been lost since an asset’s initial purchase. Calculating an asset’s accumulated depreciation is important because it allows you to determine how much a fixed asset that you own is currently worth, or its net book value.To calculate accumulated depreciation, business owners must first choose a depreciation method. There are several options that are accepted under GAAP (generally accepted accounting principles).Recommended: What Is An Alternative Depreciation System (ADS)?
How Does Accumulated Depreciation Work?
Through depreciation, a business will spread out the total cost of a fixed asset over the course of its useful life. This means that each year the asset is put to use and generates revenue, the business will record the cost associated with using up the asset as a depreciation expense on the income statement.Accumulated depreciation is the total amount an asset has been depreciated up until a certain point. So, for example, if the asset depreciates by $10,000 each year, the accumulated depreciation at the end of two years of service is $20,000.An asset's book (or carrying) value on the balance sheet is the difference between its original cost and accumulated depreciation. At the end of an asset's useful life, its book value on the balance sheet will match its salvage value (the estimated resale value of an asset at the end of its useful life).Accumulated depreciation is a credit balance on the balance sheet (also known as a contra account). It is the total amount of an asset that is expensed on the income statement over its useful life.
Calculating Accumulated Depreciation
So how do you calculate accumulated depreciation? While there are multiple ways to calculate depreciation itself, there is only one way to calculate accumulated depreciation: You add up the total amount an asset has depreciated for each year it has been in use. The sum of each year’s depreciation amount equals an asset's accumulated depreciation.
Accumulated Depreciation Formula
The simplest way to calculate accumulated depreciation is with the following formula (which utilizes the straight-line method of depreciation):Accumulated Depreciation = (Original Cost - Salvage Value) / Life of the Asset x YearsFor example, if an asset cost $20,000 and has a ten-year useful life cycle and no salvage value, it would depreciate approximately $2,000 a year. Therefore, after the third year of ownership, that asset will have an accumulated depreciation of $6,000. Accumulated Depreciation = $20,000 / 10 x 3Accumulated Depreciation after 3 years = $6,000
Pros and Cons of Accumulated Depreciation
The process of calculating depreciation and accumulated depreciation has myriad benefits, but it isn’t always easy or perfectly accurate. Here’s a look at its pros and cons.
Pros
Cons
Helps reduce a company’s tax burden
Can be complicated and cumbersome to calculate
Enables businesses to report the correct net book value of a given asset
Small business software typically does not offer depreciation calculation
Necessary to determine taxable gain on the sale of an asset
Some depreciation methods are based on guesswork and don’t account for higher losses in the short-term
Pros
By depreciating an asset each year, a business can lower their taxable income, which, in turn, can lower their tax bill. Keeping track of an asset's accumulated depreciation allows you to determine an asset's correct book value. Assets experience wear and tear from regular use, so the actual value declines over time. Depreciation helps show this.In addition, accumulated depreciation provides valuable insight into a company's capital gains and losses when it sells or stops using an asset. The accumulated depreciation of an asset is also necessary to determine the taxable gain on the sale of an asset.
Cons
There are multiple ways to calculate depreciation and, in some cases, the process can be complicated and cumbersome. Unfortunately, small business accounting software programs typically don’t offer depreciation calculations.If you opt for the simplest depreciation method (called the straight-line method), the calculation is largely based on guesswork. In addition, this method doesn’t factor in the accelerated loss of an asset’s value in the short-term or the likelihood that maintenance costs will likely go up as the asset ages.
4 GAAP Depreciation Methods
Even if your company isn’t public, you can still follow GAAP procedures. Here are four GAAP-compliant depreciation methods.Recommended: Non-GAAP vs GAAP
1. Straight Line
The straight-line method of depreciation is the simplest way to calculate depreciation. You first subtract the asset's estimated salvage value (or resale amount) from its original cost. Next, you divide that number by the total years of the asset’s useful life. (Note: The Internal Revenue Service (IRS) offers a list of useful life estimates.) Straight-line depreciation formula:Annual Accumulated Depreciation = (Cost of the Asset - Salvage Value) / Useful Life in Years
2. Declining Balance
The declining balance method is an accelerated method of depreciation, meaning you charge more of an asset's depreciation early in its usable life and less in its later years, as the asset loses usability and value. New companies or those expecting less revenue in their first years may choose this method to lower tax bills by claiming larger depreciation expenses in earlier years.The declining balance method depreciates an asset at the same rate for each year of its useful life. However, the amount depreciated each year changes as the book value of the asset is reduced. Declining balance formula:Annual Accumulated Depreciation = Current (or Beginning) Book Value x Depreciation Rate Where:Current (or Beginning) Book Value = Cost of the asset - Salvage ValueWith this method, the current book value is the beginning value at the start of the year, and this figure changes every year. To determine the beginning book value after the first year, you need to subtract the accumulated depreciation from the previous year’s current book value.
3. Units of Production
With the units of production depreciation method, you estimate how many units an asset will be able to make over the course of its useful life. This method can be useful when an asset's value lies in the number of units it produces or in how much it's used, rather than in its lifespan. The units of production formula has two parts:
(Cost of Asset - Salvage Value) / Estimated Total Units = Units of Production Rate
Units of Production Rate x Actual Units Produced = Annual Accumulated Depreciation
4. Sum-of-the-Year's Digits
The sum-of-the-year’s digits method accelerates an asset's depreciation so that most of the depreciation costs occur early on in an asset’s useful life. It can be most useful for assets that are not expected to last very long. With this method, the remaining life of an asset in years is divided by the sum of the years (more on that below) and then multiplied by the depreciating base to determine the depreciation expense.The sum-of-the-years-digits formula:Annual Accumulated Depreciation = (Remaining Life / Sum of the Years Digits) x (Cost – Salvage value) To simplify this equation, here are the steps involved in calculating the sum-of-the-year’s digits:
Cost of the Asset - Salvage Value = Depreciable Base
Determine the sum of the useful years of the asset by adding up each digit in the number. Example: 10 years would equal 55 because 1+2+3+4+5+6+7+8+9+10 = 55
A faster formula is n(n+1) / 2
Example: 10(10+1)/ 2= 55
Calculate the depreciation factor by dividing the remaining useful life of the asset by the sum of the useful years. Example: 10/55, 9/55/ 8/55, etc.
For an asset with a 10-year useful life, you would multiply the depreciable base by 10/55 for the first year. In the second year, you would multiply it by 9/55 and so on until the last year where the factor would be 1/55.
Accumulated Depreciation Examples
To illustrate how to calculate accumulated depreciation using the different methods described above, let’s use a work truck as an example. Let’s say the truck cost $60,000 to purchase, has a $5,000 salvage value, an estimated 10 years of life, and a depreciation rate of 20%.
Straight Line Example
For the straight-line method, the business owner would claim $5,500 each year for ten years.$55,000/10= $5,500 After 2 years, accumulated depreciation would be $11,000.
Declining Balance Example
Here’s how the truck would depreciate for the first two years:
$55,000 (Book Value) x 20%(Depreciation Rate) = $11,000 (Annual Accumulated Depreciation for the first year)
$55,000 - $11,000 = $44,000 (Book Value at end of first year)
$44,000 x 20% = $8,800 (Depreciation Expense for the second tax year)
$44,000 - $8,800 = $35,200 (New Book Value after second tax year)
The accumulated depreciation after two years: $11,000 (Year 1) + $8,800 (Year 2) = $19,800
Units of Production Example
If the truck the business purchased is expected to last 200,000 miles and the owner drives 40,000 miles the first year, then:
$55,000/ 200,000 = 0.275 (Units of Production Rate)
0.275 x 40,000 = $11,000 (Annual Depreciation)
If the owner drives the same amount in the second year, the total accumulated depreciation would be $22,000.
Sum of the Year’s Digits Example
The truck has an estimated useful life of 10 years, so the sum of years digits is 55.
For year 1 the equation would be:Annual Depreciation = (10/55) x ($60,000 - $5,000)Accumulated Depreciation for Year 1 = $9,999
For year 2 the equation would be: Annual Depreciation = (9/55) x ($60,000 - $5,000)Accumulated Depreciation for Year 2 = $8,999Accumulated depreciation amount after 2 years is $18,998 ($9,999 + $8,999).
The Takeaway
Accumulated depreciation helps a company determine an asset’s net worth, which in turn affects the company’s total net worth. While there are a variety of methods to calculate an asset’s depreciation, there is only one way to calculate an asset’s accumulated depreciation. This is done by adding up the depreciated amount for each year that has occurred since the asset was put into service. If your company needs to purchase a big-ticket asset but doesn’t have the cash on hand, you may want to consider different types of small business loans, including equipment loans, bank loans, short-term loans from online lenders, and Small Business Administration (SBA) loans.
3 Small Business Loan Tips
Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can compare small business loans by filling out one application on Lantern by SoFi.
Traditionally, lenders like to see a business that’s at least two years old when considering a small business loan.
SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.
Frequently Asked Questions
Is accumulated depreciation considered an asset or a liability?
How is accumulated depreciation calculated?
What is the use of accumulated depreciation?
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About the Author
Lauren Ward
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
