Is Accumulated Depreciation an Asset or a Liability?

If you’ve been paying attention to our blogs, you know that we’ve written a great deal about the concept of depreciation, and for good reason. Deprecation can provide certain tax benefits to help offset taxable income generated from investments. 

Accumulated depreciation is also useful in this sense. But determining whether accumulated depreciation is an asset or liability requires some explanation. 

Understanding Accumulated Depreciation

Let’s first review depreciation. Depreciation is an income tax deduction that allows you to use the cost of property or assets that are placed in service to offset certain types of income.

Basically, you can spread those purchase costs—and other expenses generated while owning the asset—across its “useful life,” or the number of years it will remain in service to generate revenue. Because assets wear down over time, the IRS both estimates the asset’s useful life, while permitting the loss of the asset’s value over that time as a depreciation from ordinary income.

Taking this one step further, accumulated depreciation represents the total amount of depreciation expense tagged to a specific asset, from the time when that asset was put into use until when it’s retired or sold.

Here are a couple of other issues:

• Accumulated deprecation can’t exceed an asset’s cost.
• The amount of an asset’s accumulated depreciation increases over time, as depreciation continues to be charged against that asset.

Accounting Review: Assets and Liabilities

Now let’s move to Accounting 101 to discuss assets and liabilities. Specifically:

• An asset is a resource that generates cash flow or some other economic benefit. Examples include cash equivalents, accounts receivables, patents, inventory, and investments (including real estate).
• A liability (in the accounting sense) is something that is owed, such as debt that needs to be paid, unpaid bills, or IOUs.
• Assets, liabilities, and equity are reported on a balance sheet which, in turn, shows what’s owned and what’s owed.

Where Accumulation Depreciation Fits In

With the above explanations in hand, accumulated depreciation is neither an asset (a resource that generates cash flow or economic value) nor a liability (something that is owed).

So where does it fit? Accumulated depreciation is what is known as a “contra asset.” Specifically, its purpose is to offset, or reduce, the value of an asset with which it’s paired. One way to think about a contra asset account is that it’s an asset account with a credit balance. 

This means that accumulated depreciation shows up on a balance sheet as a reduction from the reported fixed asset’s gross amount. Once that asset is retired or sold, the accumulated depreciation account’s amount connected to that asset is reversed. 

Understanding accumulated depreciation can be important when determining tax strategies. Work with your tax professional to determine how this can be used with your particular investment parameters.