Accumulated Depreciation

One of the most important management tasks for any business is managing its finances to meet evolving needs. Accounting department has to keep an eye on the financial health of the company. There are several accounting calculations involved, which evaluate 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 asset value is the accumulated depreciation. The aim of this article is to define this finance term and stress the importance of calculating this value, when evaluating the overall health of any company.

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 a variable value which is dependent on its market value and applicability. To know what is meant by accumulated depreciation of financial assets, one needs to grasp the concepts of appreciation and depreciation of value. There are some assets whose value appreciates with time, while there are some whose value depreciates. Other than real estate investments, most of the other assets, which are a part of company inventory depreciate with time.

What is Accumulated Depreciation?

It is the sum of the progressive loss 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 it 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 the actual value of an asset, by accounting for the passage of time. Even when calculating asset value for tax calculation, depreciation value does make a difference.

How is it Calculated?

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

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

Thus, you must calculate depreciation value of every asset owned by a business to get the overall cumulative depreciation value.

Importance
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 the depreciation into consideration, you are going to look at an inflated asset value. Accumulated depreciation appears on the company balance sheet and provides you with a more precise valuation of your investment. 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.