Accumulated Depreciation
Accumulated depreciation is when a company records the depreciation of an asset on the balance sheet over its useful life. Depreciation is an accounting methodology used to spread the capital costs of physical assets out over their useful lives. Companies use it to allocate a portion of the cost to each accounting period. The portion that is allocated for that period is an expense. Companies record the portion allocated for each period as an accumulated depreciation.
Accumulated depreciation is the sum of all prior years depreciation adjustments on a companys fixed asset accounts, such as equipment or buildings. At the time of purchase, the cost is entered into an asset account, and over the time of the assets useful life, the accumulated depreciation amount is recorded in a contra asset account.
Accumulated depreciation is subtracted from the original cost of an asset to determine the assets net book value. This value is used to assess the assets current market value, which is important, especially when the company wants to determine if the asset has any remaining value. The book value of an asset may also be used to set insurance coverage and tax assessment purposes.
Accumulated depreciation is also included in the calculation of return on assets (ROA).ROA is the ratio of net income to total assets and measures how efficiently the company utilizes its assets and how financially sound the company is. Since depreciation is an expense, it reduces the assets net income thereby reducing the ROA.
Accumulated depreciation may also be referred to as the accumulated amortization or the total accumulated depreciation. In certain countries, such as Germany and France, depreciation costs are amortized instead of depreciated. Amortization is the gradual reduction of the value of an asset or debt by equal periodic payments. Therefore, the terms accumulated depreciation and accumulated amortization may be used interchangeably in certain situations.
Accumulated depreciation is an important accounting concept which allows companies to evenly spread out the cost of an asset over its useful life to better reflect the true value of the asset in the financial statements. Companies use this information to make sound business decisions regarding the asset and how to best use it.
