Is accumulated depreciation a fixed asset?
Is accumulated depreciation a fixed asset? When companies purchase assets, they try to estimate how long they will be able to use the asset before it losses its value. The projected time frame of asset use is known as the asset’s useful life span. When the useful lifespan of an asset has been determined, journal entries are made yearly to account for its reduction in value or depreciation. Accumulated depreciation is the cumulative reduction in the value of an asset that has been determined up until the period under consideration.
Accumulated depreciation is recorded on the balance sheet of companies under the property, plant, and equipment (PP&E) section. It is a contra-asset account which means that it has a natural credit balance that reduces the total asset value. We shall further discuss accumulated depreciation and fixed assets so that we determine whether accumulated depreciation is a fixed asset.
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Accumulated depreciation and fixed asset explained
Accumulated depreciation recognizes depreciation over the lifespan of an asset instead of recognizing the expense at once in the company’s financial records. A large percentage of companies rely on various fixed assets such as equipment, buildings, machinery, vehicles, and plant to ease their daily operations, increase cash inflow and reduce expenditure. We shall further discuss accumulated depreciation and fixed assets to understand what each term means.
What is accumulated depreciation?
Accumulated depreciation appears on the balance sheet as a reduction from the gross amount of the company’s fixed assets. Generally, companies expense a portion of an asset’s value over each year of its useful lifespan. This is based on the generally accepted accounting principles (GAAP) matching principle which stipulates that expenses must be matched to the same accounting period when the related revenue was generated.
Thus for each year that an asset is put to use and generates revenue, the associated cost of using the asset is recorded in the same year as depreciation expense. Accumulated depreciation is the cumulative depreciation expense for an asset from when it was first used up until the period under consideration. Hence, for each accounting period, prior depreciation expense for an asset is added to the beginning accumulated depreciation balance of that asset.
The value of an asset on the balance sheet is the original cost of purchasing the asset minus its accumulated depreciation up until the accounting period under review. When the useful lifespan of an asset has been exceeded, the asset’s value will match its salvage value. The salvage value of an asset is the amount a company expects to receive when they sell an asset at the end of its useful lifespan. Hence, accumulated depreciation is a record of the total decrease in the value of the assets owned by a company.
For example, if a company purchases a vehicle for $5,000,000 and its estimated useful lifespan is 5 years. In order for the company not to record a huge loss when it purchased the vehicle and for its accounting books to be balanced, a depreciation expense account is created to account for the yearly reduction in the value of the vehicle. When the vehicle has been used for say 3 years, its accumulated depreciation becomes the sum of all its yearly depreciation expenses until its third year.
The accumulated depreciation account shows how much of an asset has been consumed or used by the company that owns it from the time of its purchase to the time under consideration.
What is a fixed asset?
Assets are resources that have the ability to decrease the outflow of cash, increase the inflow of cash, or both. They provide current or potential economic benefits to the individuals or corporate entities that own them. Before a resource is considered an asset for a company, the company must have owned the asset at the date of its financial statements. Assets are broadly divided into fixed, intangible, financial, and current assets.
Assets are purchased or created to increase the value of a company, ease daily operations and bring positive benefits to the company. These assets aid in reducing expenses, generating revenue, and improving sales.
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Is accumulated depreciation a fixed asset?
Accumulated depreciation reduces the book value of an asset and has a natural credit balance, unlike fixed assets that have a natural debit balance. The book value of an asset is the difference between the original cost of purchasing the asset and its accumulated depreciation. This means that accumulated depreciation reduces the total balance of a company’s assets instead of increasing it. When reported on the balance sheet, accumulated depreciation is reported in the assets section under fixed assets (property, plant, and equipment) but this does not make accumulated depreciation a fixed asset since it subtracts from, rather than adds economic value to the company.
For all fixed assets that a company owns, its perceived lifespan must be determined from the time of its purchase and its depreciation expensed over this estimated lifespan such that by the time the asset’s lifespan is used up, the company’s financial records must have recognized this steady reduction in value. As a result of this continuous recognition of the asset’s depreciation over the years, the asset’s end value becomes the same as the value at which the company expects to sell off the already depreciated asset.
Additionally, fixed assets represent physical resources that increase cash inflows, reduce cash outflows, increase efficiency and generally ease daily business operations while accumulated depreciation is an account that captures the amount of economic value that has been consumed by a company from the assets they own. Furthermore, accumulated depreciation does not increase cash inflows, reduce cash outflows, increase efficiency or ease daily business operations.
Accounting for accumulated depreciation is a method of accounting that companies use to allocate the cost of fixed assets over their useful lifespan by steadily recognizing their decline in value over the time of their use. This helps companies in avoiding major losses in the particular year when they purchased a fixed asset due to the spread in the cost of the purchase over its useful lifespan.
As a contra-asset account, accumulated depreciation accounts for equalizing the fixed asset account and is reported on the same financial statement as the fixed assets (property, plant, and equipment). Accumulated depreciation increases as the company’s fixed assets depreciate in value over time. Hence accumulated depreciation is used to reduce the value of fixed assets when the two are netted together. Companies, therefore, record accumulated depreciation on their balance sheet to reduce the gross value of their fixed assets.
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Conclusion
Is accumulated depreciation a fixed asset? Accumulated depreciation is not a fixed asset, it is instead a contra-asset account. This means that it reduces the book value of an asset over time. It has a natural credit balance while fixed assets have a natural debit balance.
The confusion of whether accumulated depreciation is a fixed asset often arises from the fact that it is recorded along with property, plant, and equipment or just below them. Although property, plant, and equipment are all fixed assets, accumulated depreciation is not a fixed asset. Instead, it is an account that records the steady decline in the value of assets as they get used by companies. Hence it is a record of the cumulative depreciation of an asset from its purchase date until a specified date.
Accumulated depreciation is closely related to the salvage value of an asset and its book value. The salvage value of an asset is its expected selling price after it is fully depreciated or after its useful lifespan has been exceeded. The book value of an asset is the difference between the original cost of purchasing the asset and its accumulated depreciation. Based on our discussion here, we can categorically say that accumulated depreciation is not a fixed asset.
Companies create an accumulated depreciation account to keep their financial records up to date. Instead of reducing the value of their fixed assets directly from the fixed assets account, the accumulated depreciation account makes it possible to retain the historical cost of purchase of the fixed asset while reducing its depreciation from a separate account. This makes tax preparation easier and less time-consuming.
