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Accumulated depreciation: what it is, how to calculate it, and where it goes
Accumulated depreciation is a contra-asset with a credit balance that reduces equipment on the balance sheet....
Quick answer
Depreciation expense is the portion of a long-lived asset's cost recognized in one accounting period. For equipment used to run the business it is usually an operating expense, in operating expenses or cost of goods sold. It is non-cash: debit depreciation expense, credit accumulated depreciation.
Depreciation expense is the slice of an asset's cost that is charged against one accounting period. A $12,000 commercial mower expected to last five years and sell for $2,000 at the end carries $2,000 of depreciation expense a year under the straight-line method, or about $166.67 a month.
The cash left the business when the mower was bought. Depreciation expense spreads that cost across the years the mower helps earn revenue, so each year's profit reflects the equipment it used up.
This guide answers the questions people usually arrive with: whether depreciation is an operating expense, how to calculate it, where it goes in the financial statements, and how it differs from accumulated depreciation. It does not choose a depreciation method or tax position for a particular business; that belongs with your accountant.
Is depreciation an operating expense?
Usually, yes. When the asset is used to run the business — vehicles, machinery, computers, furniture, a building the business occupies — its depreciation is part of the cost of operating and is included before operating income is calculated.
Where it appears depends on what the asset does:
| Asset | Where its depreciation usually goes |
|---|---|
| Production machinery and factory equipment | Cost of goods sold, as part of the cost of making the product. A manufacturer first includes it in the cost of inventory, and it reaches the income statement when that inventory is sold |
| Office computers, furniture, delivery vans, the sales team's cars | Operating expenses, often within selling, general and administrative expenses or on its own line |
| An asset held as an investment rather than used in operations | Non-operating expense, below operating income |
Some companies show depreciation as its own line instead of folding it into cost of sales. The SEC's staff guidance for public companies, Staff Accounting Bulletin Topic 11.B, says that when cost of goods sold excludes depreciation the caption must say so — for example, "Cost of goods sold (exclusive of depreciation shown separately below)". Either way, it is still counted before operating income.
That is also why EBITDA exists: earnings before interest, taxes, depreciation and amortization adds depreciation back to show operating performance before the cost of long-lived assets. EBITDA is a non-GAAP measure; operating income under normal accounting includes depreciation.
Why people doubt it
Depreciation feels different from rent or wages because no money leaves the business when it is recorded. It is a non-cash expense. But "operating" describes what the cost relates to, not whether cash moves this month. A business that ignored depreciation would overstate its profit every year it used the equipment and then show a large loss the year it replaced it.
How to calculate depreciation expense
The straight-line method, the most common for book purposes, has three inputs:
- Cost — the purchase price plus the costs to get the asset ready for use, such as delivery and installation.
- Salvage value — what you expect to recover at the end of its useful life. Our salvage value guide covers how to estimate it.
- Useful life — how long the business expects to use it, in years or months.
Annual depreciation expense = (cost − salvage value) ÷ useful life
Monthly depreciation expense = annual depreciation expense ÷ 12
Worked example
A landscaping company buys a commercial ride-on mower for $11,400 and pays $600 in delivery and sales tax, so its cost is $12,000. It expects to use the mower for five years and sell it for $2,000.
- Depreciable base: $12,000 − $2,000 = $10,000
- Annual depreciation expense: $10,000 ÷ 5 = $2,000
- Monthly depreciation expense: $2,000 ÷ 12 = $166.67
| Year | Depreciation expense | Accumulated depreciation | Net book value |
|---|---|---|---|
| 1 | $2,000 | $2,000 | $10,000 |
| 2 | $2,000 | $4,000 | $8,000 |
| 3 | $2,000 | $6,000 | $6,000 |
| 4 | $2,000 | $8,000 | $4,000 |
| 5 | $2,000 | $10,000 | $2,000 |
The expense is the same every year; the accumulated total grows until the book value reaches the salvage value, and then depreciation stops.
The first and last year
Assets rarely arrive on the first day of the year. If the mower was placed in service on April 1, a monthly convention records nine months in year one: $2,000 × 9 ÷ 12 = $1,500. The remaining three months fall into a sixth calendar year. Choose one convention — months in service, a half-year, or starting the month after purchase — record it in your asset policy, and apply it to every asset.
Other methods
Straight-line is not the only method. Declining balance methods charge more depreciation in the early years and less later, which suits assets that lose value quickly. Units of production ties the expense to use, such as machine hours or miles, so it rises and falls with activity. The method changes how the total is spread across periods; it never changes the total, which is always cost minus salvage value.
To compare methods for a specific asset, try the free depreciation calculator, which shows straight-line and double-declining balance side by side.
Where depreciation expense goes in the financial statements
Depreciation expense touches all three main statements.
Income statement. It reduces profit in the period. A landscaping company sells a service rather than a product, so the mower's depreciation is an operating expense. A simplified year for the business:
| Income statement | Amount |
|---|---|
| Revenue | $310,000 |
| Crew wages | ($168,000) |
| Fuel, plants and materials | ($52,000) |
| Yard rent | ($24,000) |
| Depreciation expense | ($2,000) |
| Operating income | $64,000 |
Balance sheet. The same amount is added to accumulated depreciation, which reduces the equipment's carrying amount. See our accumulated depreciation guide for how it is presented.
Cash flow statement. Because no cash moved, depreciation is added back to net income when operating cash flow is prepared using the indirect method. The cash outflow appears once, as a capital expenditure in investing activities, in the year the asset was bought.
The journal entry
Each period, depreciation is recorded with one entry:
| Account | Debit | Credit |
|---|---|---|
| Depreciation expense | $2,000 | |
| Accumulated depreciation — equipment | $2,000 |
Depreciation expense has a debit balance, like other expenses, and is closed to retained earnings at the end of each year. Accumulated depreciation has a credit balance and carries forward until the asset is disposed of.
Depreciation expense vs accumulated depreciation
| Depreciation expense | Accumulated depreciation | |
|---|---|---|
| What it measures | The cost charged in one period | Every period's charge added together |
| Statement | Income statement | Balance sheet |
| Account type | Expense | Contra-asset |
| Normal balance | Debit | Credit |
| Resets? | Yes, every year | No, until the asset is disposed of |
Book depreciation vs tax depreciation
The figures above are book depreciation, used in the financial statements. Tax depreciation follows its own rules. In the US, IRS Publication 946 describes depreciation as "an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property," and sets out the tax methods, including MACRS. Businesses claim it on Form 4562, which is also where the section 179 election to expense certain property is made.
Publication 946 also lists what cannot be depreciated, including land, property placed in service and disposed of in the same year, and property with a useful life of one year or less. Because tax rules often allow faster write-offs than a business uses in its books, the depreciation expense in the financial statements and the depreciation deduction on the tax return are frequently different numbers for the same asset. Keep both, clearly labeled, and let your accountant own the tax figures. If you need the IRS recovery period for an asset, the free asset class lookup finds it.
How AssetCenter fits
AssetCenter's fixed asset management software includes a straight-line depreciation report that shows each asset's annual depreciation, accumulated depreciation and net book value. Salvage value is subtracted before the cost is spread, the first year is prorated from the month of purchase, and the report exports to Excel for your bookkeeper.
The report reads from the operational record AssetCenter already keeps: what each asset is, what it cost, where it is, who has it, and when it was retired or sold. It does not calculate tax depreciation, post journal entries, or replace your accounting system.
Frequently asked questions
Is depreciation expense a debit or a credit?
A debit. Like other expenses, it increases with a debit. The matching credit goes to accumulated depreciation.
Is depreciation expense an asset?
No. It is an expense on the income statement. The related balance-sheet account, accumulated depreciation, is a contra-asset that reduces the value of equipment.
Is depreciation a fixed cost?
Under the straight-line method, yes: the same amount is charged each period regardless of activity. Under units of production it behaves like a variable cost, because it rises with use.
Does depreciation expense reduce taxes?
Tax depreciation reduces taxable income. Book depreciation expense reduces reported profit, but the deduction on the tax return is calculated under tax rules and may be a different amount.
Is depreciation included in EBITDA?
No. EBITDA is calculated before depreciation and amortization. Operating income, EBIT and net income all include it.
What is the difference between depreciation and amortization?
Depreciation spreads the cost of tangible assets such as equipment and buildings. Amortization does the same for intangible assets such as software licenses and patents.
Next step: calculate one asset, then build the schedule
Take one asset with a known cost, in-service date, useful life and salvage value, and work it through the formula above or the depreciation calculator. Then use the fixed asset depreciation schedule guide to extend the same calculation to every asset you own and reconcile the total to your general ledger. Before you start, make sure the item belongs on the schedule at all: is equipment a current asset? explains which purchases are depreciated and which are simply expensed.
Founder & CEO, AssetCenter
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