Where Is Accumulated Depreciation on the Balance Sheet?

Accumulated depreciation is an important accounting concept that reflects the reduction in value of a company’s assets over time But where exactly does accumulated depreciation show up on the balance sheet? In this comprehensive guide, we will demystify where accumulated depreciation sits on the balance sheet and why proper reporting of accumulated depreciation is vital for businesses

What is Accumulated Depreciation?

First let’s review what accumulated depreciation is. Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life. This allocation is done as an expense on the income statement rather than recording the entire cost of an asset in the year purchased.

Accumulated depreciation is the total amount of depreciation expense allocated to a specific asset up to a single point in time. The purpose of accumulated depreciation is to reflect on the balance sheet the reduction in book value of the asset due to usage, wear and tear over time.

For example, if a company purchases a vehicle for $20,000 that has a 10-year useful life, the company may record $2,000 in depreciation expense per year. After 5 years, the vehicle would now reflect $10,000 in accumulated depreciation on the balance sheet.

Accumulated depreciation is often referred to as a contra account, as it has a credit balance that reduces the normally debit-balanced asset account.

Where Is Accumulated Depreciation on the Balance Sheet?

On a company’s balance sheet, accumulated depreciation appears in the asset section immediately below the capital asset it is associated with.

For example, a company’s balance sheet may show:

Equipment, net:
Equipment at cost: $100,000
Less: Accumulated depreciation (25,000)
Net equipment: $75,000

By presenting accumulated depreciation directly below the related asset, it clearly shows the relationship between the two accounts and allows financial statement users to easily discern that the net carrying value of the equipment is $75,000.

Some key facts about the presentation of accumulated depreciation:

• Accumulated depreciation has a credit balance, unlike most other asset accounts.
• Accumulated depreciation is shown indented under the capital asset account to demonstrate it reduces that account’s value.
• The capital asset account will be shown in its gross historical cost or fair value amount first.
• Accumulated depreciation will immediately follow below it.
• The net amount of the two accounts will be labeled to show the remaining “net” asset value.

This clear presentation allows readers of the financial statements to see the original acquisition cost, the amount of depreciation expense accumulated to date, and the remaining book value amount.

Why Properly Record Accumulated Depreciation?

There are a few key reasons why properly recording accumulated depreciation is important:

1. Reflects asset’s net book value – Without accumulating depreciation on the balance sheet, assets would stay at their historical cost. This would overstate the company’s asset balances and not reflect the economic reality that assets decline in utility over time.

2. Impacts financial ratios – Since accumulated depreciation reduces assets, it impacts key financial ratios like return on assets. Failing to properly record accumulated depreciation would distort these ratios.

3. Tax implications – Depreciation expense recorded on the income statement provides a tax deduction for businesses. Not recording accumulated depreciation could lead to errors and sub-optimal tax planning.

4. Provides information to investors – Investors and lenders use accumulated depreciation to get insight into the useful remaining life of assets. This helps inform forecasts and valuation models.

5. Complies with accounting standards – Recording accumulated depreciation adheres to Generally Accepted Accounting Principles (GAAP) and standards like ASC 360. Not properly recording accumulated depreciation would violate standards.

Real World Examples of Accumulated Depreciation

To better understand accumulated depreciation in practice, let’s walk through a few examples:

Example 1

ABC Company buys a new piece of machinery for $20,000. ABC estimates the useful life of the machinery to be 10 years, with a $2,000 salvage value.

For accounting purposes, the depreciable base is $20,000 – $2,000 = $18,000. Using straight-line depreciation, ABC will record $1,800 in depreciation expense per year for 10 years.

After 5 years, ABC’s balance sheet will show:

Machinery:
Machinery at cost: $20,000
Less: Accumulated depreciation (9,000)
Net machinery: $11,000

The accumulated depreciation reflects 5 years x $1,800 per year = $9,000 accumulated depreciation.

Example 2

DEF Inc. buys a new company vehicle for $22,000. The vehicle is expected to have a useful life of 8 years and a salvage value of $2,000.

The depreciation expense using straight-line depreciation is ($22,000 – $2,000) / 8 years = $2,500 per year.

After 3 years, DEF Inc.’s balance sheet will report:

Vehicle:
Vehicle at cost: $22,000
Less: Accumulated depreciation (7,500)
Net vehicle: $14,500

The $7,500 accumulated depreciation represents the 3 years x $2,500 depreciation recognized so far.

Example 3

GHI Company buys a new office building for $200,000. The building is estimated to have a useful life of 25 years with a salvage value of $25,000.

The depreciable base is $200,000 – $25,000 = $175,000. The straight-line depreciation will be $175,000 / 25 years = $7,000 per year.

After 10 years, GHI’s balance sheet will report:

Building:
Building at cost: $200,000
Less: Accumulated depreciation (70,000)
Net building: $130,000

The $70,000 accumulated depreciation equals the 10 years x $7,000 annual depreciation expense.

Key Takeaways

• Accumulated depreciation is shown on the balance sheet directly below the related capital asset account as a contra asset.

• It has a credit balance and reduces the typically debit-balanced asset account.

• The presentation clearly displays the asset cost, accumulated depreciation, and remaining net book value.

• Recording accumulated depreciation is vital for financial reporting and tax compliance.

• The balance sheet presentation adheres to accounting standards and principles.