Is accumulated depreciation an asset? How to calculate it

What is accumulated depreciation?

Accumulated depreciation is the total (accumulated) depreciation of an asset since its purchase.

Keeping track of it allows you to record the true value of the asset on your financial statements. This value, known as the book value (asset cost – accumulated depreciation), is what the asset is realistically worth today.

For example:

• Office furniture cost $5000, with $1000 depreciation each year. After 3 years it has depreciated by $3000, leaving a book value today of $2000.
• Machinery cost $25,000, with $2500 depreciation each year. After 6 years it has depreciated by $15,000, leaving a book value today of $10,000.

Depreciation vs accumulated depreciation

Depreciation is a recurring expense that shows the decrease in an asset’s value over a certain period, like a month or a year.

Accumulated depreciation, on the other hand, is the cumulative total of all these depreciation expenses recorded for an asset. It increases each time you add a new depreciation expense.

Here’s more information about depreciation

Is accumulated depreciation an asset or a liability?

Accumulated depreciation is actually neither an asset nor a liability.

Liabilities typically represent amounts your business owes or obligations it must fulfill. Accumulated depreciation, however, is not a debt to be repaid – it’s the reduction of an asset’s book value over time (due to things like wear and tear).

Instead, Accumulated depreciation is considered a contra asset account. A contra asset isn’t an asset in the traditional sense – it’s a tool that offsets the original value of assets on the balance sheet.

While you record the contra asset alongside your other assets, it always has a negative value, showing how accumulated depreciation reduces an asset’s value from its original cost. This gives a more realistic estimate of an asset’s book value.

How does accumulated depreciation affect financial statements?

Accumulated depreciation on the balance sheet

Accumulated depreciation reduces an asset’s book value on the balance sheet.

Although a balance sheet lists the asset’s original cost, accumulated depreciation adjusts this value downwards to reflect the asset’s current worth.

Accumulated depreciation on the income statement

Depreciation is recorded as an expense, and therefore reduces your taxable income.

As a non-cash expense, it lowers your profits without affecting cash flow.

Accumulated depreciation on the cash flow statement

Because depreciation doesn’t affect cash flow, it's added back to net income on the cash flow statement.

This adjustment reflects that depreciation is an accounting expense, not a cash outflow.

Example: Balance sheet for accumulated depreciation

Visualise how accumulated depreciation changes the net book value of assets and affects overall financial health.

How to calculate accumulated depreciation

Here’s how to calculate accumulated depreciation using the straight line depreciation method – a formula used by many small businesses.

The straight line depreciation calculation

To use the straight line depreciation method, start by calculating the annual depreciation expense with this formula:

Annual depreciation expense = (cost of asset − salvage value) / useful life

Definitions of each term

• Cost of asset: the original purchase price of the asset.
• Salvage value: the estimated amount you’ll receive for the asset when it’s no longer usable. This could be the resale value or scrap value.
• Useful life: the estimated number of years the asset will be functional before it becomes unusable or obsolete.

Each of these affects the annual depreciation expense differently.

For example, an asset with a short useful life spreads depreciation over fewer years, resulting in a higher annual depreciation expense.

But if an asset holds its value well and has a relatively high salvage value, it’ll depreciate less each year, leading to a lower annual depreciation expense.

Calculate straight line depreciation

Now, let’s calculate accumulated depreciation using the straight line depreciation method. In this example, our asset cost $1000, has a useful life of 5 years, and a salvage value of $100.

Step 1: Calculate the annual depreciation expense

Using our formula above, our example gives us:

($1000 – $100) ÷ 5 = $180 per year

Step 2: Track accumulated depreciation each year

Create a depreciation schedule to track how accumulated depreciation increases each year by the depreciation expense. In our example:

Year 1 (1 x $180) = $180 Year 2 (2 x $180) = $360 Year 3 (3 x $180) = $540 Year 4 (4 x $180) = $720 Year 5 (5 x $180) = $900

Step 3: Calculate the asset’s book value at a point in time

Use the formula:

Book value = initial cost – accumulated depreciation

In our example, after 3 years, the asset’s book value is:

$1000 – $540 = $460

Why understanding accumulated depreciation matters for a business

• Better business planning: Monitoring fixed asset depreciation allows small business owners to track changes to their assets’ values over time, making it easier to plan replacements or upgrades and to estimate upcoming maintenance.
• Potential tax savings: Depreciation charges reduce your business’s taxable income, lowering your tax bill and keeping more cash in the business.
• Easier financing: Correctly accounting for accumulated depreciation and presenting an accurate book value of depreciated assets improves your chances of attracting investment and having loan applications approved.

FAQs about accumulated depreciation

Here are some of the most commonly asked questions about accumulated depreciation.

How does accumulated depreciation affect cash flow?

Because accumulated depreciation is a non-cash expense, it doesn’t directly affect cash flow. It measures the asset’s value reduction over time, so there’s no physical cash outflow – cash doesn’t leave the business.

But accumulated depreciation (and depreciation in general) does reduce taxable income, which lowers your tax liability. By helping you pay less tax – and therefore keeping more cash in the business – accumulated depreciation improves your business’s cash position.

What happens to an asset’s accumulated depreciation when you sell it?

An asset’s accumulated depreciation is removed from the balance sheet when you sell it.

The asset’s book value at the time of disposal (asset cost – accumulated depreciation) is compared with the sale price to determine a net gain or loss.

Do I record accumulated depreciation as a debit or a credit?

Record accumulated depreciation as a credit on the balance sheet because it's classed as a contra asset – an account type that reduces the value of an asset.

Since assets typically have debit balances on the balance sheet, accumulated depreciation is credited against the depreciating asset to reflect its falling value over time. This lowers the asset’s book value without affecting cash flow.

Is accumulated depreciation a current liability?

No – accumulated depreciation is not a current liability. It’s recorded on the balance sheet as a contra asset – an account type that reduces the value of an asset.

Current liabilities are short-term debts due within 12 months, whereas accumulated depreciation lowers the book value of an asset over time – it isn’t an amount owed that you have to repay.

Here’s more about current and non-current liabilities.

Simplify your accounting with Xero

Managing depreciation, adjusting entries, and calculating accumulated depreciation quickly gets complicated – especially as your business grows.

Xero simplifies these tasks by streamlining your accounting processes and helping you manage and track your assets. For instance, you can create detailed depreciation schedules that give you a clear view of fixed asset values and improve the accuracy of your financial reporting.

Learn how Xero supports your business