Is Accumulated Depreciation a Current Asset?
An asset is anything of value that your business owns to sell or use as a way to earn income. Examples of assets include cash, accounts receivable, inventories, machinery, vehicles, and land. Assets are categorized into current assets and noncurrent assets.
Current assets are items a business owner expects to liquidate into cash within a year. On the other hand, noncurrent assets are things your company doesn't plan to sell or would typically take more than a year to sell.
Another category also falls under noncurrent assets: fixed assets. These are items used in the day-to-day operations of your business and aren't for sale. Examples include machinery, vehicles, and office furniture. To account for the wear and tear that happens over the use of a fixed asset, you'd record depreciation expenses every accounting period.
Accumulated depreciation is the total of all depreciation expenses recorded against an asset since it was acquired. This is why accumulated depreciation is called a "contra-asset account." Contra-asset accounts reduce the balance of the asset account with which they're paired.
This article will review what accumulated depreciation is, why it doesn't qualify as a current asset, and how to record it.
Is Accumulated Depreciation an Asset or a Liability?
To understand accumulated depreciation, we should define fixed assets, as they're generally paired together. Fixed assets are items that a business bought for the purpose of using them to make its products or render a service. These are long-term assets, which means they have an expected useful life of more than a year.
Practically and financially, it wouldn't serve your business to write off the total cost of an asset the year it is acquired. It's also not beneficial to pretend these assets will last forever or expense their total costs the year they cease to be useful.
As an example, let's say you have a plumbing business that acquired a new truck this year. Let's assume the car cost $55,000, and you earned $75,000 for the year. If you record the $55,000 as an expense, you would have almost zero income after accounting for all other costs.
Taking the above approach will not only land you in hot water with the Internal Revenue Service (IRS), but you would also be violating the matching principle set out by generally accepted accounting principles (GAAP). The matching principle is based on a cause-and-effect relationship. It requires companies to match expenses with income earned during specific accounting periods to properly account for a company's profitability.
This is why you're expected to record a depreciation expense for fixed assets you own and use in your business. Depreciation allows you to divide an asset's cost over its useful life and record it against the income earned while the asset is in use. Hence, accumulated depreciation is neither an asset nor a liability.
Where Is Accumulated Depreciation on the Balance Sheet?
Generally, accumulated depreciation accounts are paired with the fixed asset accounts found on the balance sheet's property, plant, and equipment section. Since accumulated depreciation is a contra-asset account, it reduces the recorded amounts of the fixed assets with which they're paired.
You can find accumulated depreciation accounts right below a fixed asset, or a company may choose to have the total amount as one line item at the bottom of the asset's section on the balance sheet.
It's good accounting practice to show accumulated depreciation amounts on the balance sheet because it gives you and other financial statement users a more accurate representation of your business's assets. You can check the original cost of the asset, deduct accumulated depreciation, and easily calculate the net book value.
To get a list of your assets and have a closer look at how depreciation works, why not try creating a balance sheet for your business with Skynova's accounting software? It's an invoicing and accounting software that can help you organize and record your income and expenses accurately.
What Is an Accumulated Depreciation Journal Entry?
A journal entry is an accounting practice where you record a business transaction in your company's ledger. A journal entry generally includes a correct date, amounts to be debited and credited, and an explanation of the transaction. A journal entry for depreciation would be a debit to the "Depreciation Expense" account and a credit to the "Accumulated Depreciation" account.
|January 31, 2021||Depreciation Expense||$1,000|
|Accumulated Depreciation||$1,000||To record depreciation expenses for the month of January.|
The amount you'll record as an expense will depend on the method of depreciation you use. Below are brief discussions and examples of the different depreciation methods.
The straight-line depreciation method is a simple and straightforward calculation where you divide the asset's depreciable value over its useful life. To calculate the depreciable value, you deduct the salvage or residual value from the total cost. The straight-line depreciation expenses the same amount against the value of the asset every accounting period.
As an example, let's take a look at the truck from our discussion above. The total cost of the vehicle, including purchase price, transport, and registration, is $52,500. We'll assign a useful life of five years and assume that you can sell it for $2,500 at that time. The annual depreciation expense, if you use the straight-line method, would be $10,000.
The sum-of-the-years'-digits (SYD) is a depreciation method that lets you write off more of an asset's cost in the early years of its useful life and less in the later years. This method is meant to represent the actual value of an asset's usefulness. To calculate SYD depreciation, you add up the digits in the asset's life span to come up with a fraction that you will apply to each year of depreciation.
For example, the SYD for an asset with a useful life of five years is 15: 1 + 2 + 3 + 4 + 5 = 15. You divide the asset's remaining life span by the SYD and then multiply the number by the cost to get your depreciation expense. Let's calculate the amount of depreciation expense for the first year of the same truck from our example above. The total cost is $52,500 with a salvage value of $2,500.
|SYD Depreciation Expense|
The depreciation expense for the first year of the truck would be $16,667.
The double-declining-balance (DDB) depreciation is an example of an accelerated depreciation method that records larger depreciation amounts during the earlier years of an asset's useful life. The "double" refers to the practice of recording double the amount calculated in the straight-line method. Meanwhile, the "declining balance" refers to the asset's remaining book value at the beginning of the accounting period. Business owners use this method for assets they think will lose most of their value during their early years or become obsolete quickly.
To illustrate, let's calculate the first two years of depreciation expense for the truck from our previous examples. The total cost is $52,500, with a useful life of five years and a salvage value of $2,500.
|=||2 x Straight-Line Depreciation Rate x Book Value at the Beginning of the Period|
To calculate the straight-line depreciation rate, we'll use this formula:
|Straight Line Depreciation Rate|
|First-Year Depreciation Expense|
|=||2 x Straight Line Depreciation Rate x $52,500|
|=||2 x 20% x $52,500|
|Second-Year Depreciation Expense|
|=||2 x Straight Line Depreciation Rate x $52,500|
|=||2 x 20% x ($52,500 - $21,000)/td>|
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Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional accountant for specific advice regarding bookkeeping best practices.