The aggregate depreciation of an asset up to a certain point in its life is termed as accumulated depreciation. The carrying value of an asset in the balance sheet or the sheet of financial position (SOFP) is the difference between its price of purchase and accumulated depreciation. A company acquires and holds an asset on the balance sheet until the salvage value is equal to the carrying value.
Accumulated Depreciation: A Breakdown
There are two kinds of assets: Assets that are used during the year of purchase and those that are capitalized. Assets that are used within the year of their purchase such as inventory are referred to as operating assets. Either they are sold or used during the year of purchased and so are expensed in this year. Capitalized assets, on the other hand, remain valuable for more than one year and accountants are always looking to match expenses to sales in the period in which they took place. Depreciation can be termed as a solution to this matching dilemma. Depreciation uses a segment of the cost of the asset in the year it is purchased and the remaining as the asset is used in the future years. Accumulated depreciation is the total amount that the asset has been used over its lifespan.
We divide the difference between the cost of an asset and its salvage value by the assets expense life in order to get the straight-line depreciation expense. In this instance, the cost of the asset is the purchase price, the salvage value is the value of the asset when it has been expensed and is also known as scrap value and the useful life is the number of years that asset is considered to be valuable.
A certain Company X purchases a piece of equipment with a useful life of 10 years for $110,000. The equipment boasts a salvage value of $10,000 when it has been expensed. The equipment is expected to remain valuable for the company for the coming 10 years, so experts expense the cost of the equipment over the next decade. Straight-line depreciation comes out to be $110,000 divided by 10 or $10,000. This means that the company will depreciated $10,000 for the next decade until the book value of the asset is left as $10,000.
The contra asset account also known as the Accumulated Depreciation increases by $10,000 each year. For instance, after five years, the annual depreciation expense is still $10,000 but accumulated depreciation has become $50,000. This means that the accumulated depreciation is a cumulative or aggregate account. It is credited every year as the value of the asset is written off and remains on the books until the asset has been dispensed with. It is pertinent to keep in mind that the accumulated depreciation cannot be more than the cost of the asset even if the asset is being used after its useful life.