Companies use depreciation and accumulated depreciation to record the asset value and the expense correctly as the assets are being used. Looking at these in detail would enable to understand the ways in which they work.
What is Depreciation?
Depreciation is an accounting term which helps companies to record the reducing value of the assets (e.g. buildings, furniture & fittings, equipment etc) being used. Even if assets are purchased the depreciation can only be calculated from the point of them being used in the business; i.e, the depreciation is calculated from the time an asset is used / placed for service. Also, the depreciation is recorded periodically. Hence, cost is allocated periodically as value lost due to usage, and this is taken as an expense for the period, which affects the business’s net income. Depreciation is calculated taking the cost of the asset, the expected useful life of the asset, residual value of the asset and percentage if necessary. There are different methods to calculate the depreciation amount. The two main methods in use are Straight Line depreciation and Declining balance method / reducing balance method. Straight Line depreciation being the simplest and most often used technique calculates depreciation by taking the asset value after deducting its residual value (future value) and apportioning in equal amounts to be taken throughout the useful life of the asset. Declining balance method charges a higher amount during the initial period of the asset’s life.
What is Accumulated Depreciation?
Through accumulated depreciation, the asset value in the balance sheet is reduced to show the effect of loss of value due to usage. E.g. If we have an equipment (asset) which has an original cost of $1,000 and the residual value or resalable value in 3 years time would be $400. Hence the company has to bear the $600 as the loss which would be spread across the 3 years. If the company doesn’t record any depreciation during the assets usage in the company then the full loss at the end of 3 years would have to be recorded for that year which would not show the correct picture to its shareholders, as the asset’s wear and tear was not accounted for during the time it was in the company. In the first year, the depreciation would be (if using straight line) $200, and in the 2nd year, the depreciation of $200 and accumulated depreciation of $400 will be recorded. Therefore, the accumulated depreciation of $600 for the equipment should be accounted for during the 3 years. Hence each year the asset’s value would be shown deducting the value for wear & tear / usage.
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What is the difference between Depreciation and Accumulated Depreciation? Even though, both are in relation to reduction in the asset value, differences exist between the two. • Depreciation is recorded as expense in the income statement whereas accumulated depreciation is disclosed in the balance sheet. • Depreciation is the reduction in value of the asset for the current period, whereas accumulated depreciation is the addition of all of the depreciation (accumulated) recorded up until that point of time (e.g. depreciation of $200 for each year, whereas accumulated depreciation for the 2nd year would be $400 and $600 for the second year and so on). |
Conclusion
As illustrated above, accumulated depreciation accumulates the total asset depreciation from the time of usage. Depreciation is an account on the income statement which is closed on each accounting period, whereas accumulated depreciation is on the balance sheet which stays on until the asset is disposed/sold.