One of the students taking my Real Life Accounting for Non-Accountants online accounting course e-mailed me with a question about “Accumulated Depreciation”. He was having a real hard time comprehending why that account existed. To me, it was clear as a bell. To him, he simply could not see it. I tried explaining it from several different angles and after many e-mails it started to dawn on him. Perhaps there are more people like him who haven’t yet grasped the full concept of depreciation. So let’s discuss how depreciation is journalized. You can review how to understand the process of depreciation using the “straight-line and double-declining methods” in my latest article, “Understanding Depreciation – It’s not as hard as you might think”.
In the article, I explain how a portion of the cost of a fixed asset is allocated to the Depreciation Expense general ledger account each accounting period. The method of doing that requires a debit entry to Depreciation Expense because that general ledger account is being increased (therefore a debit entry) by the allocated cost of the fixed asset. As you know, the rule of double-entry accounting is that the debit entries must equal the credit entries when all is said and done. This means a credit entry must be made for the amount equal to the Depreciation Expense entry.
The credit entry is recorded in an account called “Accumulated Depreciation”. This account is located in the Asset section of the Balance Sheet under Fixed Assets. It can be one account that contains all the accumulated depreciation for various categories of fixed assets such as, Office Equipment, Furniture & Fixtures, Machinery & Equipment, Vehicles, Leasehold Improvements, etc. Or, it can be set up as a separate account located below the fixed asset account it relates to. For example:
Furniture & Fixtures
Accumulated Depreciation – Furniture & Fixtures
It doesn’t matter as it’s up to you.
The main concept to understand here is that the Accumulated Depreciation account is an offset to the Fixed Asset accounts. You could call it a “contra” account. Remember that even though the Accumulated Depreciation account is located in the Asset section it maintains a credit balance. Fixed Assets when purchased are posted as a debit balance because an increase is being recorded. When a portion of the fixed asset is removed and recorded in the Depreciation Expense account then that decrease is recorded in the Accumulated Depreciation account as a credit. This makes sense because the Accumulated Depreciation account’s purpose is to reflect how much of the fixed assets that have been expensed.
Looking at it a different way, we could have simply recorded a credit to the fixed asset account directly. So instead of seeing a fixed asset balance of $500 we might see $450. The problem with this method is that it would be difficult to know at a glance how much we purchased the fixed assets for originally and how much depreciation we have expensed. Using an Accumulated Depreciation account provides us with more information.
Let me know if you have any questions about how this works.
John
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