The most basic difference between depreciation expense and accumulated depreciation lies in the fact that one appears as an expense on the income statement, and the other is a contra asset reported on the balance sheet. Both pertain to the “wearing out” of equipment, machinery or another asset, and help to state a true value for the asset.
Depreciation expense is reported on the income statement as any other normal business expense. If the asset is used for production, the expense is listed in the operating expenses area of the income statement. This amount reflects a portion of the acquisition cost of the asset for production purposes. For example, factory machines that are used to produce a clothing company’s main product have attributable revenues and costs. To determine attributable depreciation, the company assumes an asset life and scrap value. The depreciation expense for a $500,000 machine that is expected to have a value of $100,000 in 5 years is $80,000 per year. This is calculated by $500,000 – $100,000 / 5 = $80,000. As there are no rules on determining scrap value and life expectancy, investors should be wary of overstated life expectancies and scrap values.
Accumulated depreciation is a running total of depreciation for an asset that is recorded on the balance sheet. An asset’s original value is adjusted during each fiscal year to reflect a current, depreciated value. For example, the machine in the example above that was purchased for $500,000 is reported with a value of $300,000 in year three of ownership. Again, it is important for investors to pay close attention to ensure the management is not boosting book value behind the scenes through depreciation-calculating tactics.