When to Use Depreciation Expense Instead of Accumulated Depreciation

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, an important consideration when making year-end tax deductions and when a company is being sold and the assets need a proper valuation.

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 that management is not boosting book value behind the scenes through depreciation-calculating tactics, although the tactic is often used to depreciate assets beyond their real value. This is done for a few reasons, but the two most important reasons are that the company can claim higher depreciation deductions on their taxes, and it stretches the difference between revenue and liabilities. This makes the company seem more profitable than they might truly be.

Depreciation is used on an income statement for almost every business. It is listed as an expense, and so should be used whenever an item is calculated for year-end tax purposes or to determine the validity of the item for liquidation purposes.

Accumulated depreciation, on the other hand, should–but often is not–listed directly below the depreciation of the item to show the running total. This makes it an easier read for the accountant and gives a more astute sense into the lifetime of the item from a business perspective.

Both types of depreciation should be listed on year-end and quarterly reports, but it is depreciation that is the more common of the two due to its application regarding deductions and can help lower a company's tax liability. Accumulated depreciation is used more to forecast the lifetime of an item, or to keep track of depreciation year-over-year.