Over time, a fixed asset depreciates in value from the start of its useful life. Accumulated depreciation is the depreciation expense allocated to that business asset. The value of the asset that is "used up" over time is transferred to the asset's accumulated depreciation account and recorded as an expense.
According to generally accepted accounting principles (GAAP), a few different depreciation calculation methods can be used to tally the monthly depreciation of the value of an asset. Therefore, the accumulated depreciation formula you use will vary.
How to Calculate Accumulated Depreciation
Three common ways of calculating accumulated depreciation, either annually or monthly, are the straight-line method, the double-declining balance method and the sum-of-the-years' digits method. Each of these employs simple calculations to determine the depreciation of an asset over time. For each one, you'll need to know three things about the asset:
- Original purchase price – the total price of the purchase of an asset
- Salvage value – the estimated value of an asset at the end of its useful life
- Length of useful life – how long an asset is expected to be in service
Using the Straight-Line Method
The straight-line value calculates equal annual depreciation for every year of the asset's useful life until it gets down to salvage value.
Example of Straight-Line Depreciation Method
A business purchases a piece of equipment for $10,000, knows the salvage value is $2,500, and the useful life is five years. Calculating annual or monthly accumulated depreciation is as follows:
Calculation | Example | |
|---|---|---|
| Annual Depreciation: | Subtract the asset's salvage value from the original cost of the asset, then divide it by the useful life to get the yearly depreciation expense. | ($10,000 - $2,500)/5 years = $1,500 per year |
| Monthly Depreciation: | Divide the annual depreciation by 12 to determine the monthly depreciation expense. | $15,000/12 = $125 per month |
To determine the depreciation expense over a specific accounting period, use the monthly or annual depreciation calculation to learn how much accumulated depreciation has occurred over time. To calculate the asset's current net value, subtract the accumulated depreciation from the asset's original purchase price.
Using the Double-Declining Balance Method
According to the State of Idaho Controller's Office, the double-declining method calculates the first year at double the depreciation rate of the straight-line method. Then it repeats the calculation to determine the depreciation on the changing total value over time. In the double-declining method, salvage value isn't part of the calculation.
Example of the Double-Declining Method
A business purchases equipment for $10,000 with a five-year useful life and a salvage value of $2,500.
Calculation | Example | |
|---|---|---|
| Determine the annual depreciation rate for year one: | Multiply two (2) by the number one (1) over the number of useful years in the asset's useful life. | 1/5 (represents year one over the five year useful life) or 0.2. Multiply that by 2. 0.4 is the depreciation rate for the first year. |
| Determine the total accumulated depreciation for the first year: | Multiply the first year's depreciation percentage by the original cost. | 0.4 x $10,000 = $4,000 |
| Calculate the monthly accumulated depreciation: | Divide the first year's accumulated depreciation by 12. | $4,000/12 = $333.33 |
The beginning book value for the second year is the original cost minus the accumulated depreciation in the first year. In the example above, $10,000 minus $4,000 leaves a beginning book value of $6,000 for year two. For the second year's accumulated depreciation, start the calculation from step one, multiplying $6,000 by 0.4 to get $2,400 annual or $200 monthly depreciation.
Repeat the steps to calculate the beginning book value for the asset in subsequent years of the asset's useful life until the asset is depreciated down to its salvage value.
Using Sum-of-the-Years' Digits Method
When using the sum-of-the-years' digits method, add all the digits for each year of the asset's useful life, determine a specific percentage for each year and multiply that percentage by the remaining life of the investment, explains the Corporate Finance Institute.
Example of Sum-of-the-Years' Digits
With a piece of equipment purchased for $10,000, an estimated useful life of five years and a salvage price of $500, you would start at 5, representing the total useful life of the machine, and add to it each number of years back to one: 5, 4, 3, 2, 1. The sum of those digits, in this case, is 15.
Calculation | Example | |
|---|---|---|
| Determine the percentage of annual depreciation: | Divide each year's digit by the sum of the useful life digits. | Year one: Divide 5 by 15 to calculate 33.33 percent, the percentage of equipment depreciation in the first year. Year two: Divide 4 by 15 to arrive at 26.67 percent, the percentage amount it depreciates in its second year. Years three through five: Repeat this process, dividing each number down to one by 15 until you have calculated a depreciating percentage for each of the asset's useful life years. |
| Determine the total accumulated depreciation for the first year and subsequent years: | Multiply the asset's original purchase price or depreciating amount (cost minus salvage value) by the percentage for the year that you're calculating the accumulated depreciation. | Year one: ($10,000 – $500) x .3333 = $3,166.35 Year two: ($10,000 - $500) x .2667 = $2,533.65 Years three through five: Repeat this process until you have calculated the accumulated depreciation for each of the asset's useful life years. |
| Calculate the monthly accumulated depreciation: | Divide the result by 12 to calculate the monthly accumulated depreciation. | In this instance, dividing $3,166.35 by 12 equals $263.86, the amount of depreciation expense that accumulates monthly in the first year. Repeat the process for each of the useful life years of your asset to determine the monthly depreciation amount. |
Monthly vs. Annual Appreciated Depreciation
Calculating monthly accumulated depreciation as a line item on a balance sheet helps to show the original cost of an asset, its current value, how much of the asset has been written off and how much useful life is remaining. The depreciation expense for an asset will be recorded at the end of each fiscal year or when an asset is disposed of.
A business or financial advisor uses a depreciation schedule to track the total amount of depreciation over the useful life of an asset. Small business owners may use annual depreciation at tax time as a deduction to recover the cost of assets over time. The IRS has specific rules about this allowance.
Accumulated Depreciation Expense on a Company's Balance Sheet
When a company pays cash for capital assets such as buildings, machinery, property, vehicles and other equipment, the purchased items are recorded as assets since the company owns them. Accumulated depreciation is different from depreciation expense, which is an expense on the income statement. The wear and tear on those items – the accumulated depreciation – is a contra-asset account, or debit, on the income statement. It is listed with the assets on a balance sheet.
According to the GAAP matching principle, when a depreciation expense is recorded in a journal entry, that same amount is recorded as a credit to the accumulated depreciation account in the same current period. The balance sheet will show the asset's net book value.
Accumulated Depreciation vs. Accumulated Amortization
Accumulated depreciation tracks the declining value of tangible assets over time, while amortization is used to depreciate intangible assets such as software licenses, trademarks and designs. Similar to how accumulated depreciation is calculated, amortization is tracked over time by dividing the value of the intangible asset by the years of its useful life. Both reduce the value of an asset and appear on a company's financial statements.
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