Depreciation Expense vs. Accumulated Depreciation

One of the most confusing concepts in accounting is distinguishing between depreciation expense and accumulated depreciation.  First, these are two separate accounts.

Depreciation expense pertains to any depreciation incurred during the present period and thus belongs on the Income Statement.  Here’s an example from Target Stores, which combined depreciation expense and amortization expense into a single line item.

Accumulated depreciation includes not just depreciation incurred during the present period, but depreciation from prior periods.  Accumulated depreciation appears on the Balance Sheet and is a contra-asset account; it is subtracted from property, plant, and equipment to obtain property, plant, and equipment, net.  Note that Target Stores had $18.181 billion in accumulated depreciation as of February 3, 2018, whereas it incurred about $2 billion in depreciation expense for the year ended February 3, 2018.

Target Income Statements (in millions) 2017 2016 2015
Sales $71,879 $69,495 $73,785
Cost of sales 51,125 49,145 52,241
Gross Margin 20,754 20,350 21,544
Selling, general, and administrative expenses 14,248 13,356 14,665
Depreciation and amortization 2,194 2,025 1,969
Gain on sale (620)
Earnings from continuing operations before interest and taxes 4,312 4,969 5,530
Net interest expense 666 1,004 607
Provision for income taxes 718 1,296 1,602
Net earnings from continuing operations 2,928 2,669 3,321
Discontinued operations, net of tax 6 68 42
Net Income $2,934 $2,737 $3,363
Target’s Assets (in millions) Feb 3, 2018 Jan 28, 2017
Current Assets:
Cash and cash equivalents $     2,643 $     2,512
Inventory 8,657 8,309
Other current assets 1,264 1,169
          Total current assets 12,564 11,990
Property and equipment:
          Land 6,095 6,106
          Buildings and improvements 28,396 27,611
          Fixtures and equipment 5,623 5,503
          Computer hardware and software 2,645 2,651
          Construction-in-progress 440 200
          Accumulated depreciation (18,181) (17,413)
          Property and Equipment, net 25,018 24,658
Other noncurrent assets 1,417 783
Total assets $     38,999 $     37,431
Year

Depreciation Expense

Accumulated Depreciation

1 $     8,000 $     8,000
2 $     8,000 $    16,000
3 $     8,000 $    24,000
4 $     8,000 $    32,000
5 $     8,000 $    40,000

Let’s say you start a pizza restaurant and purchase a pizza oven for $40,000.  The oven (classified as property, plant, and equipment) is expected to have a useful life of 5 years and be worthless at the end of year 10.  If you record deprecation on a straight-line basis (which is what Target Stores did), then you would recognize $8,000 of depreciation expense each year.  The amount of accumulated depreciation, however, would change each year.

The accumulated depreciation at the end of year 4, for example, includes not just the $8,000 of depreciation taken during year 4 but the $24,000 of depreciation taken in years 1 through 3.

Why not simply reduce the asset account directly?

It might have occurred to you that we could simply reduce the amount of the pizza oven on the Balance Sheet instead of setting up the accumulated depreciation account.  After year 2, for example, our Balance Sheet could simply say: Pizza Oven $24,000

instead of saying:

Pizza oven $     40,000
Accumulated depreciation (16,000)
Pizza oven, net $     24,000

Reducing the asset’s book value directly is referred to as the direct writedown method, and it was used by some firms in the early 20th century.1  Companies eventually began keeping track of accumulated depreciation “on grounds of convenience” so investors could see how much wear and tear had occurred on the firm’s property, plant, and equipment.2  Whether the benefit of tracking this additional information exceeds the cost hasn’t been extensively studied, but one academic study suggests that investors do pay attention to accumulated depreciation.3

Reconciling Target’s depreciation expense to its accumulated depreciation

If you are a hardcover lover of accounting, you might be wondering why Target’s depreciation expense for fiscal year 2017 is not equal to the change in accumulated depreciation from FY 2016 to FY 2017.

This is for three reasons:

  • Target presented depreciation and amortization as a single line item

  • Target included depreciation costs in Cost of Sales

  • Target disposed of some of its property, plant, and equipment during the year

Target reported that depreciation and amortization expense was $2.445 billion after including depreciation from Cost of Sales.  To find that amount of depreciation expense excluding amortization, we need to subtract $16 million of lease-related amortization expenses.

Thus, Target must have disposed of property, plant, and equipment with $1.661 billion of accumulated depreciation associated with it during fiscal year 2017.

Isn’t depreciation fun?

Accumulated depreciation, beginning balance $     17,413
Depreciation and amortization expense (includes depreciation from cost of sales) (2,445)
Amortization expense (16)
Accumulated depreciation related to fixed asset disposal (1,661)
Accumulated depreciation, ending balance $     18,181
Depreciation Expense vs. Accumulated Depreciation

References:

  1. Simon, S. I. (1959). The right side of accumulated depreciation.  The Accounting Review, 34(1), 97-105.
  1. Airey, C. R. (1959). Depreciation:  Left or right?  The Accounting Review, 34(4) 570-571.
  1. Kang, S., & Zhao, Y. (2010). Information content and value relevance of depreciation: A cross-industry analysis. The Accounting Review, 85(1), 227-260.

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Michael McLaughlin

Michael McLaughlin, PhD, CPA, is the creator of Edspira.When he isn't making YouTube videos or writing articles, he teaches at a university in the U.S.
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