Depreciation Meaning
Over time purchased or owned assets lose their value. Their worth goes down as the usage of the assets increases. Like for example, a machine in a business will depreciate overtime the period. The value depreciates for the usage of the same. This loosing of value needs to be recorded by the business. Gradually, the level is increased and they are introduced to the Accumulated Depreciation as well. We will discuss the same in this content and give clarity about the difference between depreciation and the accumulated depreciation.
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Difference Between Depreciation Expense and Accumulated Depreciation
In this section, we will study - the difference between depreciation and the accumulated depreciation. The concept of depreciation is an integral and basic part of accounting. We need to calculate depreciation in a business to know the accurate value of an asset. The depreciation expenses are reflected in the amount of the asset which is utilized in the current year. While accumulated depreciation is the measure of the total wear and tear (depreciation) which an asset accumulates since its installation.
To know the difference between them vividly, we must priorly understand the meaning of Depreciation and the meaning of Accumulated Depreciation. Further, in our content, we will also learn about – Difference between provision for depreciation and accumulated depreciation and the difference between cost and the accumulated depreciation.
Meaning of Depreciation or Depreciation Expense
Depreciation expense is a type of expense. This is the amount of an asset; the cost of this asset has been allocated and is reported as an expense for that specific period in the income statement. This is a non-cash expense that reduces the total net income of the company.
For preparing the financial statement, the depreciation amount is to be applied against the business’s income for the particular year as prepared on the income statement.
In order to calculate the depreciation expense, we need to follow the matching principle of accounting, which says that the revenues earned in an accounting period must always be matched with their related expenses.
There are four factors that play a significant role in determining the depreciation expense. They are:
Asset cost
Salvage Value
The useful life of the asset
Obsolescence
Meaning of Accumulated Depreciation
Accumulated depreciation is basically an aggregate of depreciation expenses of a particular asset until it covers its lifetime. Accumulated Depreciation gives an idea about the relative age of the assets. The amount that is calculated as the accumulated depreciation is the asset or the group of assets that will increase over time as the depreciation expenses continue to get credit against the assets of the business.
Depreciation Expense Vs. Accumulated Depreciation
Difference Between Provision for Depreciation and Accumulated Depreciation
The provision for depreciation is actually an accounting and also taxation term. Most of the fixed assets like the plants, equipment, and vehicles decline over the time period as they are used. While accumulated depreciation is the aggregate depreciation of an asset over a time period.
In accounting, the asset value is recorded in the balance sheet after the treatment of the depreciation in order to maintain the accuracy in the value of assets with the books of Accounts. There are two methods to treat the depreciation in the Balance Sheet. One method is called the Written Down Value Method and the other method is called the Historical Cost Method. If depreciation is treated normally (that is deducting the current year’s depreciation from the asset value) then this is called the Written Down Value Method. If the Accumulated Depreciation is maintained, then it is the Historical Cost Method.
So, how is this accumulated depreciation treated? Every year, the amount of depreciation gets transferred to the Accumulated Depreciation account bypassing the following journal entry:
Provision for Depreciation A/c Dr.
To Accumulated Depreciation A/c
Hence, from the above journal entry, we can say - the asset is shown on the Balance Sheet at the cost which is incurred on its purchase. And the depreciation is being shown on the liabilities side, this is done under the head of Accumulated Depreciation. Here, the accumulated depreciation contains the whole value of depreciation which should be treated to the asset in its entire lifetime. After the Accumulated Depreciation and the cost of the asset gets equalized, then the lifetime of the asset comes to an end.
Difference Between Cost and Accumulated Depreciation
The Cost is an expenditure that is required to produce or sell a product or purchase an asset. This is done for normal use.
The Accumulated depreciation is the sum of all the recorded depreciation on the asset which certifies to a specific date.
Taking Machinery as an eEample:
If Sam buys a machine for Rs.7,000, the freight cost being Rs.1,500, and the installation cost is Rs.3,000.
The cost of that asset will be – Rs. 10,500.
If the machine works for 5 years, after which the value will be Rs. 500. This means that the value of the machine will be reduced to Rs. 2,000 per year.
Hence, at the end of the first year:
The depreciation expense will be Rs. 2000, and the accumulated depreciation will be Rs. 2000.
End of the Second Year:
The depreciation expense will be estimated as Rs. 2000, the accumulated depreciation is Rs. 4000(that is Rs. 2k for the last year & Rs. 2k for the current year)
While at the End of the Third Year:
The depreciation expense will be Rs. 2000 and the accumulated depreciation will be Rs. 6000 (which means Rs. 4k for the last two years & Rs. 2k for the current year), and so further.
Thus, we say accumulated depreciation is a depreciation that gets accumulated over a period of time.
FAQs on Difference Between Depreciation Expense and Accumulated Depreciation
1. What is the main difference between Depreciation Expense and Accumulated Depreciation?
The main difference lies in the time period they represent. Depreciation Expense is the amount of an asset's cost allocated to a single accounting period (like one year) and is shown on the Profit and Loss Account. Accumulated Depreciation is the total depreciation of an asset from the day it was purchased until the present, and it is shown on the Balance Sheet.
2. How is the annual depreciation expense for an asset calculated?
The most common method taught in the CBSE syllabus is the Straight-Line Method. The formula is:
(Cost of Asset – Estimated Salvage Value) / Useful Life of the Asset.
This calculation gives you the fixed amount of depreciation to be charged as an expense each year.
3. Where are Depreciation Expense and Accumulated Depreciation shown in the final accounts?
They are shown in two different financial statements:
- Depreciation Expense is an indirect expense and is shown on the debit side of the Profit and Loss Account.
- Accumulated Depreciation is shown on the Balance Sheet as a deduction from the gross value of the specific fixed asset.
4. Why is Depreciation considered an expense, but Accumulated Depreciation is not?
Depreciation is an expense because it represents the portion of the asset's value that has been 'used up' to generate revenue in the current year. This follows the matching principle of accounting. Accumulated Depreciation, on the other hand, isn't an expense itself. It is a running total of past depreciation expenses and functions as a contra-asset account, which means it reduces the book value of an asset over time.
5. How does a journal entry for depreciation affect both accounts?
The standard journal entry is:
Depreciation A/c Dr.
To Accumulated Depreciation A/c
This entry increases the Depreciation Expense for the year (a debit) and also increases the total Accumulated Depreciation (a credit). This correctly records the expense for the period while simultaneously reducing the asset's carrying value on the balance sheet.
6. Is Accumulated Depreciation an asset or a liability?
Accumulated Depreciation is neither an asset nor a liability. It is a special type of account called a contra-asset account. Its purpose is to decrease the value of a corresponding asset (like Machinery or Furniture) on the Balance Sheet without removing the asset's original cost from the books.
7. What is the purpose of showing Accumulated Depreciation separately on the Balance Sheet?
Showing accumulated depreciation separately upholds the historical cost principle. It allows anyone reading the balance sheet to see both the original cost of an asset and how much of its value has been written off over its life. This provides a more complete picture of a company's assets than just showing the net depreciated value.
