Depreciation is used in accounting as a means of allocating the cost of an item, usually a tangible asset, over its life expectancy. In its essence, it represents how much of an asset's value has been used up over a specific period of time.
Accumulated depreciation takes into consideration the total amount of depreciation of an asset from the point that it started being used. It is what is known as a contra account; in this case, an asset whose natural balance is a credit, as it offsets the negative value balance (debit) of the asset account it is linked to.
During an asset's useful life, its depreciation is marked as a debit, while the accumulated depreciation is marked as a credit. When the asset is removed from service, the accumulated depreciation is marked as a debit and the value of the asset as a credit. The negative accumulated depreciation offsets the positive value of the asset.
Though depreciation is a cost, which affects net income, accumulated depreciation is a bookkeeping method that does not directly affect net income.
Key Takeaways
- Depreciation allocates the cost of an item over its useful life. It impacts net income.
- Net income is the amount of revenue left after all expenses, depreciation, taxes, and interest have been accounted for.
- Accumulated depreciation is the cumulative depreciation over an asset's life.
- In accounting, accumulated depreciation is recorded as a credit over the asset's useful life.
- When an asset is sold or retired, accumulated depreciation is marked as a debit against the asset's credit value. It does not impact net income.
Depreciation and Net Income
Net income is the number left over after all cost of goods sold, operating expenses, selling, general, and administrative expenses, depreciation, interest, taxes, and any other expenses have been accounted for. It is the net earnings of a company.
A depreciationexpense reducesnet income when the asset's cost is allocated on the income statement. Depreciation isused to account for declines in the value of a fixed asset over time. In most instances, the fixed asset is usuallyproperty, plant, and equipment.
Depreciation allows a company to spread the cost of an asset over its useful life, which avoids having to incur a significant cost from being charged when the asset is initially purchased. It is an accounting measure that allows a company to earn revenue from an asset, and pay for it over the time it is used. As a result, the amount of depreciation expensedreduces the net income of a company.
Accumulated Depreciation
Accumulated depreciation is the total amount of depreciation expense that has been recorded so far for the asset. Each time a company charges depreciation as an expense on its income statement, it increases accumulated depreciation by the same amount for that period. As a result,a company's accumulated depreciation increases over time, as depreciation continues to be charged against the company's assets.
A company can increase the balance of its accumulated depreciation more quickly if it uses an accelerated depreciation over a traditional straight-line method. An accelerated depreciation method charges a larger amountof the asset's cost to depreciation expense during the early yearsof the asset.
Impact From the Saleof an Asset
When a company sells or retires an asset, its total accumulated depreciationis reduced by the amount related to the sale of the asset. The total amount of accumulated depreciation associated with the sold or retired asset or group of assets will be reversed.This causes the accumulated depreciation to be reduced by the entire amount of the assetwhen theassetis sold.
The reversal of accumulated depreciation following asale of anassetremoves it from the company's balance sheet. This process eliminates all records of the asset on the accounting books of the company.
The Bottom Line
Accumulated depreciation isa running total of the depreciation expense that has been recorded over the years and is offset against the sale of the asset. It does not impact net income or earnings, which is the amount of revenue left after all costs, expenses, depreciation, interest, and taxes have been taken into consideration. As such, the depreciation expense recordedeach period reduces net income.
