Accounting

Is Accumulated Depreciation An Asset Or A Liability?

What is Accumulated Depreciation?

Accumulated Depreciation is the cumulative depreciation expenses recognized against a Fixed Asset. It is a contra asset that contains negative amount in order to offset the asset account with which it is linked; with a view to deriving the NBV (Net book value). NBV of a fixed asset is determined as Historical Cost of the asset less accumulated depreciation of that asset.

Is Accumulated Depreciation An Asset Or A Liability?

It is neither an asset nor a liability. It is classified separately from normal assets and liabilities for multiple reasons mentioned as under.

  • It is not recognized as an asset because account balances under this accounting head will not produce any future economic benefit to an entity over time. Rather, it represents the amount of economic value that has been already enjoyed by the entity in the past periods.
  • It is not recognized as a liability because account balances under this accounting head will not give rise to a liability to an external party. Rather, this information is used for internal record keeping purposes.

If you have to provide a verdict as to whether Accumulated Depreciation should be classified as an asset or a liability, you can consider it as an asset because this is the place where the account is reported in the balance sheet.

Determine whether Fixed Assets have been purchased from Accumulated Depreciation Account balances:

It is not difficult to determine as to whether fixed assets in an entity have been purchased or not, without looking for related expense voucher. We can find it from a simple analysis that is from accumulated depreciation to fixed assets ratio. This ratio allows the analysts to understand whether new assets are being deployed by an entity.

Calculation of Ratio:

Accumulated Depreciation to Fixed Assets Ratio = Accumulated Depreciation / Fixed Assets

Explanation

An increase to the ratio indicates that management of the entity is struggling to find the cash necessary to make new investments. So, low ratio is desirable since high ratio indicates a problem. If Accumulated Depreciation to Fixed Assets Ratio increases over time it is probable that the entity may have trouble generating enough cash to procure new equipment.  If it is found true, the entity’s maintenance expense to fixed assets ratio should be analyzed to see if it is declining over time.

Formula to Calculate Accumulated Depreciation :

Accumulated depreciation is an important component of the fixed asset schedule which shows the movement fixed assets during a particular period.

Ending accumulated-depreciation balance is calculated as under:

                Beginning Balance of Accum. Depreciation

Add:       Depreciation expense for the period

Less:      Accum. depreciation on assets disposed off

=             Ending Balance of Accum. depreciation

Journal Entries:

When a fixed asset is depreciated, the depreciation expense is debited and accumulated depreciation is credited.

Depreciation expense    xxx

Accumulated- depreciation                           xxx

It is mandatory to not credit the historical cost account of the fixed asset directly because accounting standards require entities to show both the cost of fixed assets and their related accumulated depreciation- on their balance sheets or notes to the financial statements.

When an asset is disposed off, not only historical cost but also the related accumulated-depreciation is written off as follows:

Accumulated- depreciation           xxx

Fixed Asset at Cost                          xxx

The normal balance of accumulated- depreciation account is credit.

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