What is Accumulated Depreciation?

Accumulated depreciation is the sum total of the depreciation recorded for certain assets.

How Does Accumulated Depreciation Work?

Let's assume Company XYZ bought a MegaWidget for $100,000 three years ago. The MegaWidget depreciates by $10,000 a year. Thus, the accumulated depreciation recorded for the MegaWidget is:

Accumulated depreciation = $10,000 (year 1 depreciation) + $10,000 (year 2 depreciation) + $10,000 (year 3 depreciation) = $30,000.

Company XYZ will then record the net book value of the MegaWidget like this:

Net book value = $100,000 purchase price - $30,000 accumulated depreciation = $70,000

Why Does Accumulated Depreciation Matter?

Accumulated depreciation is a key component of the balance sheet and it is a key component of net book value. Net book value is the value at which a company carries an asset on its balance sheet. It is equal to the cost of the asset minus accumulated depreciation.

When a company's accumulated depreciation is high, its net book value may be below the actual market value of the company, meaning the company might be overvalued. Likewise, if the company's accumulated depreciation is low, its net book value may be above the actual market value, and the company might be undervalued.

The disparity highlights one very important aspect of accumulated depreciation: it does not reflect true losses in the market value of an asset (or company).

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.