Definition: Accumulated depreciation is the total sum of depreciation expense recorded for an asset. In other words, it’s the amount of costs the asset has been allocated thus far in its useful life.
A lot of people confuse depreciation expense with actually expensing an asset. This isn’t the case, however. Fixed assets are capitalized when they are purchased and reported on the balance sheet. No costs are initially recorded on the purchase date. Instead, the asset’s costs are recognized ratably over the course of its useful life with depreciation. This cost allocation method agrees with the matching principle since costs are recognized in the time period that the help produce revenues.
What Does Accumulated Depreciation Mean?
The accumulated depreciation account is a contra asset account that lowers the book value of the assets reported on the balance sheet. Fixed assets are always listed at their historical cost followed by the accumulated depreciation. The A/D can be subtracted from the historical cost to arrive at the current book value. This presentation allows investors and creditors to easily see the relative age and value of the fixed assets on the books. It also gives them an idea of the amount of depreciation costs the company will recognize in the future.
Let’s look at an accumulated depreciation journal entry example.
Leo’s Trucking Company purchases a new truck for $10,000 on the first of the year. Leo estimates that the truck will last for 5 years before it is completely worthless and needs to be disposed. At the end of the first year, Leo would record depreciation expense of $2,000 by debiting the expense account and crediting the accumulated depreciation account.
Since the accumulated account is a balance sheet account, it is not closed at the end of the year and the $2,000 balance is rolled to the next year. At the end of year two, Leo would record another $2,000 of expense bringing the accumulated total to $4,000. This annual entry would be recorded every year until the truck is fully depreciated. In other words, the accumulated account equals the fixed asset account.