Accumulated Depreciation Explained

One of the most important tasks for any business is managing its finances to meet evolving needs. The accounting department has to keep an eye on the financial health of the company. There are several calculations involved, which can help in evaluating the overall financial condition of a company, in terms of assets, expenses, accounts receivable, and accounts payable in any financial year. One such term, associated with the calculation of an asset's value, is the accumulated depreciation.

It is one of the most basic principles of asset management and related accounting, that the inherent value of an asset is not a constant but it's variable and is dependent on its market value and applicability.

There are some assets whose value appreciates with time, while there are others whose value depreciates. Other than real estate investments, most of the other assets, which are a part of company inventory, depreciate with time.

Accumulated depreciation is the sum of the progressive losses in the value of any tangible asset that occurs every year. It can be defined to be the total depreciation or fall in the value of an asset, since its first purchase, till the moment of calculation. Every year, as there is a further drop in the price of every company asset, it is added to the depreciation account.

Knowing the total amount of depreciation in the value of any asset, one can calculate its actual value, by accounting for the passage of time. Even during tax calculation, depreciation value does make a difference.

How the value of any asset depreciates is entirely dependent on what that asset is, its utility, and its market value. Depending on all these factors, an accountant can calculate the amount of depreciation in its value, which occurs every year, using various depreciation methods. The calculation formula is as follows:

Current Asset Value = (Purchase Value of Asset - Accumulated Depreciation)

Suppose that an asset has cost USD 30,000 to a company, when purchased and the straight line depreciation in value every year is USD 1,500. What will be the asset value, two years down the line? According to the above formula:

Asset Value After 2 Years = [USD 30,000 - (USD 1500 x 2)] = [USD 30,000 - USD 3,000] = USD 27,000

So the accumulated depreciation in this case is USD 3000. Thus, you must calculate the depreciation value of every asset owned by a business to get the overall cumulative value.

One may ask as to why is it necessary that depreciated value of assets, which accumulates over time, be taken into consideration. The reason is quite obvious. Unless you don't take it into consideration, you are going to look at an inflated value of assets. Accumulated depreciation appears on the company balance sheet and provides you with a more precise picture. A correct judgment of your asset value provides you with a basis for realistic assessment of your company's future.

Thus, it is essential that a depreciation account be maintained, as a part of the company balance sheet, for any financial year. It provides a more realistic value of company assets, which has been adjusted for the ravages of time.