Before this question is answered specifically it will be good if we clear an important connected concept of historical cost.
According to historical cost concept, assets are recognized and reported in the financial statements at the amount that were paid at the time of acquisition of the asset. And this amount remains unchanged for years to come to let users of financial statements know the price at which asset was bought.
The basic intention, in short, is to keep the information regarding the cost of acquisition paid back in time (historical cost).
Second relevant concept of this discussion is depreciation. Depreciation is a systematic allocation of cost of the asset over useful life of asset. The basic intention behind recognizing depreciation is to ensure reliability of information and this is done by reducing the value of asset at the end of each accounting period where reduction in value of assets equates the benefits extinguished or the extent to which asset has exhausted. And by the end of useful life of asset, asset will be completely exhausted and thus all of its value will depreciated as well.
Now connecting these two dots together we understand that the cost of the asset represents the value at which it was bought and depreciation represents the value of benefits consumed in particular period.
Now basic understanding says that as depreciation is the reduction in value therefore, credit the asset account. This way, the net result will be reported in the statement of financial position that shows the actual value of asset by the end of accounting period. Accounting the depreciation such way is not wrong, however, it has one major discrepancy. The problem is that after few years of depreciation recognized straight in the asset account, users of financial statements will have no idea about the value at which asset was originally purchased.
To solve this problem, instead of crediting the asset account directly a separate account is opened and the credit effect of depreciation is recorded in this new account named Accumulated Depreciation account. Accumulated depreciation account is not a temporary account and therefore, will not be closed at year rather balance in it will be carried forward from one year to other. And every year’s depreciation will be credited in this account and therefore, depreciation accounted for over time will get accumulated in this account and hence accumulated depreciation account.
This way the asset account remains unchanged, depreciation expense is recorded as usual in the income statement but in the balance sheet the year end balance of accumulated depreciation account is deducted from asset account and this way user can access three major information:
- cost at which asset was originally bought
- amount of depreciation related to asset accounted for until specific balance sheet date
- Book value of asset – which is a net result after deducing accumulated depreciation from cost of the asset
Accumulated depreciation account in itself is NOT an expense account rather it is more of an asset account of opposite nature (credit nature) and the right word that best describes such account is contra asset account as it counters or is an inverse of the asset account.