Accumulated Depreciation

Accumulated depreciation is the link between the income statement and the balance sheet for fixed assets. Each period, the depreciation expense recognized on the income statement is added to the accumulated depreciation balance. Because it offsets an asset, it carries a credit (negative) balance and is netted against gross PP&E. A machine bought for $100,000 with $60,000 of accumulated depreciation shows as $40,000 net PP&E. Crucially, accumulated depreciation is a stock (a cumulative balance at a point in time), while depreciation expense is a flow (the charge for a single period) — confusing the two is a classic interview error.

Accumulated depreciation ties the statements together. On the cash flow statement, depreciation is added back to net income (it's a non-cash charge). That same expense reduces net income on the income statement and increases accumulated depreciation on the balance sheet, lowering net PP&E. When you build a three-statement model, you typically project gross PP&E and accumulated depreciation separately so the balance sheet ties. When an asset is sold, you remove both its gross cost and its accumulated depreciation, and any difference versus sale proceeds becomes a gain or loss.

Accumulated depreciation tells you how 'old' a company's asset base is. A high ratio of accumulated depreciation to gross PP&E signals an aging asset base that may soon require heavy CapEx — a red flag in an LBO where maintenance capex eats into free cash flow available for debt paydown. It also explains why book value can diverge wildly from market value: fully depreciated assets (net book value of zero) may still be operating and generating revenue, which is part of why bankers value businesses on cash flow multiples rather than book value.