Accumulated depreciation

What it means

Accumulated depreciation is the sum of all accounting depreciation charged on a given asset since it was brought into use. It is kept on separate accounts, in group 07 for long-term intangible assets and group 08 for tangible ones, with detail for each asset item. The asset thus stays on its asset account at the original amount while its wear is shown separately.

The difference between acquisition cost and accumulated depreciation is the net book value that appears in the balance sheet. The balance sheet therefore shows three figures: the gross value, the correction in the form of accumulated depreciation, and the net value. The ratio of accumulated depreciation to cost shows how worn the company's assets are.

Accumulated depreciation is not money set aside to buy new assets, though it is sometimes read that way. It is only an accounting expression of wear. A company that wants to replace assets must have the money from operations or financing; accumulated depreciation alone does not provide it.

How it works in practice

Accumulated depreciation grows monthly or yearly according to the depreciation schedule, by booking the charge to expenses and to accumulated depreciation at the same time. When an asset is disposed of, for example sold or scrapped, accumulated depreciation is cleared against the asset account and only the net book value remains in expenses. A fully depreciated asset has accumulated depreciation equal to its cost.

With component depreciation, accumulated depreciation is tracked separately for each component, such as a building and its roof or lift. A technical improvement increases the acquisition cost and adjusts the depreciation schedule, while accumulated depreciation continues. Careful records at the level of asset cards are the basis of a proper stocktake.

In company analysis people look at the degree of wear, the ratio of accumulated depreciation to cost. A high figure points to ageing assets and upcoming investment; a low one suggests recent investment. In an acquisition or credit assessment it is one of the indicators a bank or investor asks about.

What to watch out for

Accumulated depreciation must be distinguished from impairment allowances. Depreciation reflects permanent wear and is irreversible, while allowances record a temporary fall in value and are released once the reason disappears. Confusing the two leads to errors in the balance sheet and in tax calculations.

Accounting accumulated depreciation almost never matches the tax figure. Tax depreciation is calculated under the Income Tax Act, accounting depreciation according to actual wear, so the tax and accounting net book values also differ. The difference must be tracked because it affects the tax base on sale of the asset and the deferred tax calculation.