Accumulated Depreciation
Candlefocus EditorJust as with other asset accounts, companies will initially list a capital asset at its historical cost on the balance sheet. The company can then reduce the asset's value and account for the cost of using the asset over its expected useful life by adding an accumulated depreciation account.
Contra accounts, such as accumulated depreciation, are set up with a natural credit balance, unlike standard accounts that have a natural debit balance. Thus, when recording a depreciation expense for a capital asset, the accountant must credit the accumulated depreciation account for each period's depreciation, decreasing the asset’s cost.
The net value of an asset is derived from subtracting the cost of the accumulated depreciation for that asset from the original, unadjusted cost of the asset. This net balance is known as the asset's carrying value. To maintain sound accounting records, a company must continually update this asset's carrying value by adding its annual depreciation expense, calculated with the help of any one of several accepted depreciation methods, such as the straight-line method or the declining-balance method.
Reporting accumulated depreciation on the balance sheet is intended to ensure that the business records the correct value of its assets. Accurate reporting of accumulated depreciation is also important when a business is preparing its financial statements, such as an income statement, to ensure an accurate reporting of its profits and losses as dictated by generally accepted accounting principles (GAAP).
In sum, accumulated depreciation is an accounting practice used to record the declining value of a long-term capital asset in order to tie its cost with the benefit it yields to the company over time. By accurately recording depreciation expenses and contra asset accounts, companies are able to demonstrate the cost of using and maintaining their long-term assets accurately, a key component of any financial statement.