Accumulated Depreciation

Accumulated depreciation represents the total depreciation recorded on an asset from the time it is put to use up to a given date.

• It generally increases as depreciation is recorded over the asset’s useful life.
• Assets such as machinery, technology products, automobiles, and furniture may be depreciated over time.
• Under the straight-line method, the same depreciation amount is recorded each year.
• Declining balance and double-declining balance methods record higher depreciation in the earlier years and lower amounts later.
• The sum-of-the-years' digits method also records more depreciation during the early years.
• The units of production method calculates depreciation according to how much the asset is actually used or produces.
• Accumulated depreciation helps determine the recorded value of a fixed asset over its useful life.

Accumulated depreciation is the total amount of depreciation recorded for a fixed asset over time. It includes all the depreciation charged from the time the asset is first used up to a particular date.

Suppose you own a business and purchase a fixed asset such as machinery. The asset has a certain purchase cost when you buy it, but its recorded value reduces over time as depreciation is charged.

For example, equipment used regularly in a factory may be depreciated over its useful life. Each year's depreciation is added to the depreciation recorded in earlier years to arrive at accumulated depreciation.

Examples of assets that may be depreciated include:

• Manufacturing equipment
• Technology products
• Automobiles
• Furniture

The formula used to calculate accumulated depreciation depends on the depreciation method followed.

Under the straight-line method, you first calculate annual depreciation:

Annual depreciation = (Asset cost – Salvage value) ÷ Useful life

You can then calculate accumulated depreciation for a given number of years:

Accumulated depreciation = Annual depreciation × Number of years used

For example, suppose equipment costs ₹10 lakh, has a salvage value of ₹1 lakh, and has a useful life of 10 years.

Annual depreciation = (₹10 lakh – ₹1 lakh) ÷ 10 = ₹90,000

After 5 years:

Accumulated depreciation = ₹90,000 × 5 = ₹4.5 lakh

This means a total depreciation of ₹4.5 lakh has been recorded on the equipment during the first five years.

Different depreciation methods can be used depending on how the value or usefulness of an asset is expected to reduce over its useful life.

The methods discussed here are:

• Straight-line method
• Declining balance method
• Double-declining balance method
• Sum-of-the-years' digits method
• Units of production method

Each method calculates depreciation differently. The depreciation recorded each year is then added to the amount already recorded to determine accumulated depreciation.

The straight-line method records the same depreciation expense each year over the asset’s useful life.

The formula is:

Annual depreciation = (Asset cost – Expected residual value) ÷ Useful life

In simple words, you subtract the expected value of the asset at the end of its useful life from its original cost. You then divide the remaining amount by the number of years the asset is expected to be used.

For example, suppose Company A buys a machine for ₹10,00,000. It expects the machine to have a salvage value of ₹5,00,000 after 10 years.

Annual depreciation = (₹10,00,000 – ₹5,00,000) ÷ 10 = ₹50,000

Therefore, the company records depreciation of ₹50,000 each year under the straight-line method.

Under the declining balance method, depreciation is calculated by applying a fixed depreciation rate to the asset’s current book value.

The formula is:

Annual depreciation = Beginning book value × Depreciation rate

Because the book value becomes lower each year, the depreciation expense also becomes smaller over time. However, the total accumulated depreciation continues to increase as each year's depreciation is added.

For example, suppose Company B buys an asset for ₹1,00,000 and applies a depreciation rate of 10% to its book value each year.

Year 1

₹1,00,000 × 10% = ₹10,000

Year 2

(₹1,00,000 – ₹10,000) × 10% = ₹9,000

Year 3

(₹90,000 – ₹9,000) × 10% = ₹8,100

The annual depreciation becomes smaller because it is calculated on a reducing book value.

The double-declining balance method is another method that records more depreciation during the early years of an asset's useful life.

First, the straight-line depreciation rate is calculated. That rate is then doubled.

The depreciation rate is:

Double-declining rate = (100% ÷ Useful life in years) × 2

Annual depreciation is then calculated as:

Annual depreciation = Beginning book value × Double-declining rate

For example, suppose a machine costs ₹1,00,000 and has a useful life of 10 years, with no residual value.

The straight-line depreciation rate is 10%. Therefore, the double-declining rate is 20%.

Year 1

₹1,00,000 × 20% = ₹20,000

Year 2

(₹1,00,000 – ₹20,000) × 20% = ₹16,000

Year 3

(₹80,000 – ₹16,000) × 20% = ₹12,800

The depreciation expense therefore decreases over time as the book value of the machine falls.

The sum-of-the-years' digits method records a larger share of depreciation during the earlier years of an asset’s useful life.

The formula is:

Annual depreciation = Depreciable cost × Remaining useful life ÷ Sum of the years' digits

Suppose Company E buys a machine for ₹10,000 and its useful life is 3 years.

The sum of the years' digits is:

3 + 2 + 1 = 6

The depreciation calculation is then:

Year 1

₹10,000 × 3/6 = ₹5,000

Year 2

₹10,000 × 2/6 = ₹3,333.33

Year 3

₹10,000 × 1/6 = ₹1,666.67

This method records the highest depreciation in the first year and gradually reduces the amount in later years.

The units of production method calculates depreciation according to the actual use or output of an asset rather than simply the number of years it has been owned.
The formula is:
Annual depreciation = Depreciable amount × Units used during the year ÷ Total estimated units
For example, consider a company car. Instead of calculating depreciation only according to its age, the company may estimate the total distance the car is expected to travel during its useful life.
The depreciation for each year can then be calculated according to the actual distance travelled during that year. This means the depreciation amount may change from one year to another depending on how much the asset is used.
 

Accumulated depreciation shows the total depreciation recorded on a fixed asset over time. It helps businesses understand how much of an asset's depreciable cost has already been recognised during its useful life.

Different methods calculate depreciation in different ways. The straight-line method records an equal amount each year, while declining balance, double-declining balance, and sum-of-the-years' digits methods record more depreciation earlier. The units of production method bases depreciation on actual use or output.