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Accumulated Depreciation

Guide to Understanding Accumulated Depreciation

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Accumulated Depreciation

How to Calculate Accumulated Depreciation

Depreciation represents the allocation of the purchase of a fixed asset, or capital expenditure, over its useful life.

In accrual accounting, depreciation is used to match the timing of the purchase of a fixed asset (“cash outflow”) to the economic benefits received (“cash inflow”).

If a company decides to purchase a fixed asset (PP&E), the total expenditure is incurred in once instance in the current period.

Per the matching principle, the expenditure must be spread across the useful life of the fixed asset, i.e. the number of years in which the fixed asset is expected to provide benefits.

Each period in which depreciation is recorded, the carrying value of the fixed asset, i.e. the property, plant and equipment (PP&E) line item on the balance sheet, is gradually reduced.

On the income statement, the incremental depreciation expense is recognized – most often embedded within the cost of goods sold (COGS) or operating expenses line items – until reaching its salvage value, which represents the asset’s residual value at the end of the useful life assumption.

The accumulated depreciation on a fixed asset is therefore the sum of all depreciation since the date of original purchase.

Accumulated Depreciation vs. Depreciation Expense

While the depreciation expense is the amount recognized each period, the accumulated depreciation is the sum of all depreciation to date since purchase.

Because the accumulated depreciation account is an asset that carries a credit balance, it is considered a contra asset.

Accumulated Depreciation Formula

The formula for calculating the accumulated depreciation on a fixed asset (PP&E) is as follows.

Accumulated Depreciation Formula
  • Accumulated Depreciation = [(Cost of Fixed Asset – Salvage Value) ÷ Useful Life Assumption] × Number of Years

Alternatively, accumulated depreciation can also be calculated by taking the sum of all historical depreciation expense incurred to date, assuming the depreciation schedule is readily available.

Accumulated Depreciation Calculator – Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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Accumulated Depreciation Example Calculation

Suppose that a company purchased $100 million in PP&E at the end of Year 0, which becomes the beginning balance for Year 1 in our PP&E roll-forward schedule.

The cost of the PP&E – i.e. the $100 million capital expenditure – is not recognized all at once in the period incurred.

  • Cost of PP&E Purchase = $100 million

In order to calculate the depreciation expense, which will reduce the PP&E’s carrying value each year, the useful life and salvage value assumptions are necessary.

  • Useful Life = 10 Years
  • Salvage Value = $0

Since the salvage value is assumed to be zero, the depreciation expense is evenly split across the ten-year useful life.

The depreciation incurred per year comes out to $10 million.

  • Depreciation Expense = ($100 million – $0 million) ÷ 10 Years = $10 million

In our PP&E roll-forward, the depreciation expense of $10 million is recognized across the entire forecast, which is five years in our illustrative model, i.e. half of the ten-year useful life.

By the end of Year 5, we see that the ending PP&E balance is $50 million.

The purchased PP&E’s value declined by a total of $50 million across the five-year time frame, which represents the accumulated depreciation on the fixed asset.

On the balance sheet, the carrying value of the net PP&E equals the gross PP&E value minus accumulated depreciation – the sum of all depreciation expenses since the purchase date – which is $50 million.

  • Accumulated Depreciation = $50 million

Accumulated Depreciation Calculator

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