Accumulated depreciation is the term which confuses many students of accountancy because accumulated depreciation differs from normal depreciation in the sense that while depreciation is done on yearly basis whereas accumulated depreciation is sum total of depreciation charged till date, it can be better understood with the help of an example –
Suppose a company purchased machinery in the year 2011 worth $100000 and the depreciation rate on machinery is 10 percent and company uses straight line method then in the year 2011 deprecation amount will be $10000, in the year 2012 deprecation amount will be again $10000 and till the year 2015 the total depreciation will be $50000 for 5 years and this amount accumulated for 5 years is called accumulated depreciation.
Accounting treatment of accumulated depreciation is also tricky one, initially when company has the policy of considering depreciation as accumulated depreciation then following journal entry will be passed –
Depreciation account Dr
To Accumulated depreciation account
As one can see from the above that depreciation account is debited as it is an expense while ideally asset account should have been credited but when company maintains accumulated depreciation account than it is credited and not the assets account. When company sells the asset after few years then following journal entry will be passed
Accumulated depreciation account Dr
To Asset account
As one can see from the above that once the asset is sold its account is credited making it nil in the books of account and also accumulated depreciation account is debited so as to remove it completely from the books of account. One should keep in mind that accumulated depreciation can never be more than the book value of the asset because the book value of asset is calculated as original cost of machine – accumulated depreciation till date. In balance sheet accumulated depreciation is shown as a deduction from the value of asset as it is a contra asset account.
Above example was simple however in practical life there are many complications like if company uses written down vale method or accelerated method then in accumulated depreciation account depreciation will be accumulated at faster rate or if company sells asset at more than or less than book value then accounting treatment will have to be made accordingly or if company changes method of depreciation from straight line method to written down value method or vice versa then it will affect accumulated depreciation accordingly .