Reviewed by David Kindness
Fact checked by Suzanne Kvilhaug

Accumulated Depreciation vs. Depreciation Expense: Overview

Depreciation measures how quickly an asset loses value before it breaks down or becomes obsolete. Accumulated depreciation is the total amount of an asset’s original cost that has been allocated as a depreciation expense in the years since it was first placed into service. Depreciation expense is the amount that was depreciated for a single period.

Key Takeaways

• Depreciation is an accounting method that spreads out the cost of an asset over its useful life.
• Depreciation expense is the portion of the cost of an asset that has been depreciated for a single period, reflecting how much of its value was used up in that time.
• Accumulated depreciation is the total amount of depreciation expense that has been allocated for an asset since the asset was put into use.
• Depreciation expense is recognized on the income statement as a non-cash expense that reduces the company’s net income.
• Accumulated depreciation appears in a contra account on the balance sheet reducing the gross value of fixed assets reported.

Accumulated Depreciation

Accumulated depreciation represents the sum of all depreciation expenses for a particular asset as of a certain point in time. It is recorded on a company’s general ledger as a contra account and under the assets section of a company’s balance sheet as a credit. As such, it reduces the value of the company’s fixed assets.

The amount of accumulated depreciation for an asset or group of assets will increase over time as depreciation expenses continue to be recorded. When an asset is eventually sold or retired from use, reducing its value to $0, the accumulated depreciation associated with that asset will be removed the company’s balance sheet.

Depreciation Expense

A depreciation expense, on the other hand, is the portion of the cost of a fixed asset that was depreciated during a certain period, such as a year. Depreciation expense is recognized on the income statement as a non-cash expense that reduces the company’s net income or profit. For accounting purposes, the depreciation expense is debited, while the accumulated depreciation is credited.

Depreciation expense is considered a non-cash expense because it does not involve a cash transaction. Because of this, the statement of cash flows prepared under the indirect method adds the depreciation expense back to calculate cash flow from operations. The various methods used to calculate depreciation include straight line, declining balance, sum-of-the-years’ digits, and units of production, as explained below.

Note

Accumulated depreciation is the sum of the depreciation expenses for an asset for every reporting period that the company owned that asset.

Depreciation and Accumulated Depreciation Example

Tracking the depreciation expense of an asset is important for accounting and tax reporting purposes because it spreads the cost of the asset over the time it’s in use. That can have several advantages. For one, the Internal Revenue Service (IRS) doesn’t allow businesses to fully deduct the cost of many assets in the year they are purchased but instead requires that they be depreciated and deducted over a set number of years. (There is an exception for certain assets that qualify as Section 179 property.) From a company’s perspective, having to write off a large capital cost all at once could negatively distort its profit picture for that year.

The simplest way to calculate depreciation expense is the straight-line method. The formula is: (cost of asset minus salvage value) divided by useful life.

Say a company spent $25,000 for a piece of equipment to use in its operations. It estimates that the salvage value will be $2,000 and the asset’s useful life, five years. The depreciation expense per year would be $4,600.

($25,000 – $2,000)/5 = $4,600

The accumulated depreciation for the asset would be $4,600 for the first year and grow by another $4,600 in each subsequent year. Thus, after four years, accumulated depreciation would total $18,400.

After five years there would be nothing left to depreciate.

Accumulated Depreciation and Book Value

Accumulated depreciation is used to calculate an asset’s net book value, which is the value of an asset carried on the balance sheet. The formula for net book value is the cost of the asset minus accumulated depreciation.

For example, if a company purchased a piece of printing equipment for $100,000 and the accumulated depreciation is $35,000, then the net book value of the printing equipment is $65,000.

$100,000 – $35,000 = $65,000

Accumulated depreciation cannot exceed an asset’s cost. If an asset is sold or disposed of, the asset’s accumulated depreciation is “reversed,” or removed from the balance sheet. Net book value isn’t necessarily reflective of the market value of an asset.  

Important

Depreciation expense is recorded on the income statement as an expense or debit, reducing net income. Accumulated depreciation is recorded in a contra account as a credit, reducing the value of fixed assets.

Depreciation Method Examples

The four methods allowed by generally accepted accounting principles (GAAP) are the aforementioned straight-line, along with declining balance, sum-of-the-years’ digits (SYD), and units of production.

To see how the calculations work, let’s use the earlier example of the company that buys equipment for $25,000, sets the salvage value at $2,000 and the useful life at five years.

For purposes of the units of production method, shown last here, the company’s estimate for units to be produced over the asset’s lifespan is 30,000 and actual units produced in year one equals 5,000.

The calculation for the straight-line method, as previously shown above, is (cost of asset – salvage value)/useful life:

($25,000 – $2,000)/5 = $4,600

So $4,600 will be the depreciation expense each year for the life of the asset.

The calculation for the declining balance method is current book value x depreciation rate, which in this case is 20%:

$25,000 x .20 = $5,000

The first year’s depreciation expense would be $5,000. Subsequent years’ expenses will change based on the changing current book value. For example, in the second year, current book value would be $25,000 – $5,000, or $20,000. Thus, depreciation expense would decline to $4,000 ($20,000 x .20).

This would continue each year until the amount of the deduction is less than or equal to the amount that would be obtained using the straight-line method, at which point it switches over to that method. So in this example, the declining balance method would only be advantageous for the first year.

In addition, there is another technique called the double-declining balance method that allows for an asset to be depreciated even faster, based on its straight-line depreciation amount multiplied by 200%. So in this example, the first-year depreciation could be $9,200.

The calculation for the sum-of-the-years’ digits (SYD) method is (remaining lifespan/SYD) x (asset cost – salvage cost), which works like this:

For an asset that’s being depreciated over five years, the sum-of-the-years’ digits would be 15 (1+2+3+4+5).

The formula for year one would be (5/15) x ($25,000 – $2,000) = $7,667. So the first year’s depreciation expense would be $7,667.

Subsequent years’ depreciation expenses will change as the number of years in the remaining lifespan changes. So, depreciation expense would decline to $6,133 in the second year, based on the calculation: (4/15) x ($25,000 – $2,000) = $6,133.

Finally, the calculation for the units of production method is (asset cost – salvage value)/estimated units over lifespan x actual units produced:

($25,000 – $2,000)/30,000 x 5,000 = $3,833.

The first year’s depreciation expense would be $3,833. Future years’ results will vary as the number of units actually produced varies.

What Is the Basic Formula for Calculating Accumulated Depreciation?

Accumulated depreciation is the total amount of depreciation expense recorded for an asset on a company’s balance sheet. It is calculated by summing up the depreciation expense amounts for each year up to that point.

Is Accumulated Depreciation an Asset or a Liability?

Accumulated depreciation is recorded in a contra account, meaning it has a credit balance, which reduces the gross amount of the fixed asset. As such, it is not recorded as an asset or a liability.

Is Depreciation Expense an Asset or a Liability?

Depreciation expense is recorded on the income statement as an expense, representing how much of an asset’s value has been used up for that year. It is neither an asset nor a liability.

The Bottom Line

Companies can depreciate their assets for accounting and tax purposes, and they have a number of different methods to choose from. Whichever way they decide to calculate it, depreciation expense will represent the amount for a single period and accumulated depreciation is the sum of depreciation expenses recorded for the asset up to that point.

Reviewed by Andy Smith

Modern Portfolio Theory vs. Behavioral Finance: an Overview

Modern portfolio theory (MPT) and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions is to think of modern portfolio theory as how the financial markets would work in the ideal world, and to think of behavioral finance as how financial markets work in the real world. Having a solid understanding of both theory and reality can help you make better investment decisions.

Key Takeaways

• Evaluating how people should invest (i.e., portfolio choice) has been an important project undertaken by economists and investors alike.
• Modern portfolio theory is a prescriptive theoretical model that shows what asset class mix would produce the greatest expected return for a given risk level.
• Behavioral finance instead focuses on correcting for the cognitive and emotional biases that prevent people from acting rationally in the real world.

Modern Portfolio Theory

Modern portfolio theory is the basis for much of the conventional wisdom that underpins investment decision making. Many core points of modern portfolio theory were captured in the 1950s and 1960s by the efficient market hypothesis put forth by Eugene Fama of the University of Chicago.

According to Fama’s theory, financial markets are efficient, investors make rational decisions, market participants are sophisticated, informed and act only on available information. Since everyone has the same access to that information, all securities are appropriately priced at any given time. If markets are efficient and current, it means that prices always reflect all information, so there’s no way you’ll ever be able to buy a stock at a bargain price.

Other snippets of conventional wisdom include the theory that the stock market will return an average of 8% per year (which will result in the value of an investment portfolio doubling every nine years), and that the ultimate goal of investing is to beat a static benchmark index. In theory, it all sounds good. The reality can be a bit different.

Modern portfolio theory (MPT) was developed by Harry Markowitz during the same period to identify how a rational actor would construct a diversified portfolio across several asset classes in order to maximize expected return for a given level of risk preference. The resulting theory constructed an “efficient frontier,” or the best possible portfolio mix for any risk tolerance. Modern portfolio theory then uses this theoretical limit to identify optimal portfolios through a process of mean-variance optimization (MVO).

Behavioral Finance

Despite the nice, neat theories, stocks often trade at unjustified prices, investors make irrational decisions, and you would be hard-pressed to find anyone who owns the much-touted “average” portfolio generating an 8% return every year like clockwork.

So what does all of this mean to you? It means that emotion and psychology play a role when investors make decisions, sometimes causing them to behave in unpredictable or irrational ways. This is not to say that theories have no value, as their concepts do work—sometimes.

Perhaps the best way to consider the differences between theoretical and behavioral finance is to view the theory as a framework from which to develop an understanding of the topics at hand, and to view the behavioral aspects as a reminder that theories don’t always work out as expected. Accordingly, having a good background in both perspectives can help you make better decisions. Comparing and contrasting some of the major topics will help set the stage.

Key Differences

The idea that financial markets are efficient is one of the core tenets of modern portfolio theory. This concept, championed in the efficient market hypothesis, suggests that at any given time prices fully reflect all available information on a particular stock and/or market. Since all market participants are privy to the same information, no one will have an advantage in predicting a return on a stock price because no one has access to better information.

In efficient markets, prices become unpredictable, so no investment pattern can be discerned, completely negating any planned approach to investing. On the other hand, studies in behavioral finance, which look into the effects of investor psychology on stock prices, reveal some predictable patterns in the stock market.

Knowledge Distribution

In theory, all information is distributed equally. In reality, if this was true, insider trading would not exist. Surprise bankruptcies would never happen. The Sarbanes-Oxley Act of 2002, which was designed to move the markets to greater levels of efficiency because the access to information for certain parties was not being fairly disseminated, would not have been necessary.

And let’s not forget that personal preference and personal ability also play roles. If you choose not to engage in the type of research conducted by Wall Street stock analysts, perhaps because you have a job or a family and don’t have the time or the skills, your knowledge will certainly be surpassed by others in the marketplace who are paid to spend all day researching securities. Clearly, there is a disconnect between theory and reality.

Rational Investment Decisions

Theoretically, all investors make rational investment decisions. Of course, if everyone was rational there would be no speculation, no bubbles and no irrational exuberance. Similarly, nobody would buy securities when the price was high and then panic and sell when the price drops.

Theory aside, we all know that speculation takes place and that bubbles develop and pop. Furthermore, decades of research from organizations such as Dalbar, with its Quantitative Analysis of Investor Behavior study, show that irrational behavior plays a big role and costs investors dearly.

What Is the Two Systems Theory of Behavioral Finance?

In behavioral economics, dual process theory is the hypothesis that the mind has two different systems that are both used to make economic decisions. System 1 is the part of the mind that process automatic, fight-or-flight responses, while System 2 is the part that processes slow, rational deliberation. Both systems are used to make financial decisions, which accounts for some of the irrationality in the markets.

What Are the Three Versions of the Efficient Market Hypothesis?

The efficient market hypothesis states that the markets will ultimately reach the most efficient price equilibrium in the long run. There are three ways of stating it: The weak form of the efficient markets hypothesis is that all relevant information is already reflected in current prices, and that no form of technical analysis can effectively identify inefficiencies. The semi-weak form holds that, because all relevant information is already baked into the prices, investors cannot use fundamental or technical analysis to identify undervalued stocks. The strong form holds that there is no information that can give traders an edge that is not already accounted for in current prices.

How Do Economists Account for Irrationality?

The field of behavioral economics studies the reasons why economic actors make decisions that appear irrational to an outside observer. This field is largely focused on studies of how cognitive biases and social pressures affect human choices.

The Bottom Line

While it is important to study the theories of efficiency and review the empirical studies that lend them credibility, in reality, markets are full of inefficiencies. One reason for the inefficiencies is that every investor has a unique investment style and way of evaluating an investment. One may use technical strategies while others rely on fundamentals, and still others may resort to using a dartboard.

Many other factors influence the price of investments, ranging from emotional attachment, rumors and the price of the security to good old supply and demand. Clearly, not all market participants are sophisticated, informed and act only on available information. But understanding what the experts expect—and how other market participants may act—will help you make good investment decisions for your portfolio and prepare you for the market’s reaction when others make their decisions.

Reviewed by Caitlin Clarke

When most of us think of inflation, we think of rising prices that strain budgets and take away our buying power. During the late 1970s and early 1980s, inflation skyrocketed as high as 14.8% in the United States, and interest rates climbed to similar levels. Few living Americans know what it’s like to face the opposite phenomenon: deflation.

Since too much inflation is generally regarded as a bad thing, wouldn’t it follow that deflation might be a good thing? Not necessarily, since much depends on the cause and circumstances of the deflationary cycle and how long it lasts.

Key Takeaways

• Deflation might not be a good thing, since much depends on the cause and circumstances of the deflationary cycle and how long it lasts.
• Deflation is a general decline in prices as a function of supply and demand for products and the money used to buy them.
• If prices drop because an item can be produced more efficiently and cheaply in greater quantity, such as consumer electronics, that’s viewed as a good thing.
• Deflation will result in lower interest rates as the demand for money drops, in which case, the goal is to spur buyer demand to stimulate the economy.
• There are many reasons to be concerned about prolonged deflation, and there has been continuing debate on how best to combat recessions and deflation.
• If the U.S. were to enter sustained deflation, your best protection is to hold onto your job and have as little debt as possible.

Explaining Deflation

Deflation is a general decline in prices as a function of supply and demand for products and the money used to buy them. Deflation can be caused by a decrease in the demand for products, an increase in the supply of products, excess production capacity, an increase in the demand for money, or a decrease in the supply of money or the availability of credit.

Decreased demand for products can manifest itself in the form of less personal spending, less investment spending, and less government spending. While deflation is often associated with an economic recession or depression, it can occur during periods of relative prosperity if the right conditions are present.

Practical Application

If prices are dropping because a product can be produced more efficiently and cheaply in greater quantity, that’s viewed as a good thing. An example of this is consumer electronics, which are far better and more sophisticated than ever. Yet prices have consistently dropped as the technology improved and spurred more demand.

The effect on prices by fluctuations in the demand for money is usually a function of interest rates. As the demand for money increases during a period of inflation, interest rates rise to compensate for the higher demand and to keep prices from rising further. Conversely, deflation will result in lower interest rates as the demand for money drops. In that case, the goal is to spur buyer demand to stimulate the economy.

The Great Depression

Severe economic contraction during the Great Depression resulted in deflation averaging -10.2% in 1932. As the stock market began to crater in late 1929, the supply of money declined along with it as liquidity was drained from the marketplace.

Once the downward spiral had begun, it fed on itself. As people lost their jobs, this reduced the demand for goods, causing further job losses. The decline in prices wasn’t enough to spur demand because rising unemployment undercut consumer purchasing power to a far greater degree. The snowball effect didn’t stop there, as banks began to fold as loan defaults rose dramatically.

As banks stopped lending money and credit dried up, the money supply contracted, and demand tanked. Although the demand for money remained high, no one could afford it because the supply had shrunk. Once this vicious cycle took hold, it lasted a decade until the beginning of World War II.

Possible Effects

There are many reasons to be concerned about a prolonged deflationary period, even without an event as devastating as the Great Depression:

1. Demand for goods decreases since consumers delay purchases, expecting lower prices in the future. This compounds itself as prices drop further in response to decreasing demand.
2. Consumers expect to earn less and will protect assets rather than spend them. Since 70% of the U.S. economy is consumer-driven, this would have a negative effect on gross domestic product (GDP).
3. Bank lending drops since borrowing money makes less sense in regard to the real cost. This is because the loan would be paid back with money that is worth more than it is now.
4. Deflation ensures that borrowers who loot to purchase assets lose since an asset becomes worth less in the future than when it was bought.
5. The more indebted you are, the worse your condition since your salary will likely decline while your loan payments remain the same.
6. During inflation, there is no upper limit on interest rates to control inflation. During deflation, the lower limit is zero. Lenders won’t lend for zero percent interest. At rates above zero, lenders make money, but borrowers lose and won’t borrow as much.
7. Corporate profits usually drop during a deflationary period, which could cause a corresponding decrease in stock prices. This has a ripple effect on consumers who rely on stock appreciation and dividends to supplement their incomes.
8. Unemployment rises, wages decline as demand drops, and companies struggle to make a profit. This has a compounding effect throughout the entire economy.

What to Do

Ever since the Great Depression, there has been continuing debate on how best to combat recessions and deflation. During the 2007–2009 Great Recession, then-Federal Reserve Chair Ben Bernanke adopted a policy of quantitative easing, which essentially amounts to printing money to buy U.S. Treasuries. Following the Keynesian economic theory, he used the money supply to offset the economic contraction that resulted from the financial meltdown in 2008 and the bursting of the housing bubble. Bernanke’s actions contributed to the recovery of the global economy, but economists argued that he flooded the economy with too much money, contributing to inflation and increased individual and corporate debt.

If the U.S. were to enter a sustained deflationary cycle, your best protection is to hold onto your job and have as little debt as possible. You don’t want to be locked into paying off a loan with money that is increasing in value every day. Save as much money as possible and defer discretionary purchases until prices are lower. Finally, consider selling assets that you don’t need while they still have value.

What Is Deflation?

Deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of currency rises over time.

What Are Causes of Deflation?

Causes of deflation include:

• Decreased availability of credit
• Decreased demand for products
• Decreased supply of money
• Excess production capacity
• Increased demand for money
• Increased supply of products

What Is Your Best Defense Against Deflation?

Your best protection from deflation is to hold onto your job and have as little debt as possible. If you’re an investor, protect your portfolio by investing in assets that perform well even in times of deflation. Such defensive hedges include high-quality bonds, companies that produce essential consumer goods, and cash.

The Bottom Line

Too much inflation is generally regarded as a bad thing, but deflation might not necessarily be regarded as a good thing. It depends on the cause and circumstances of the deflationary cycle and how long it lasts.

Your best protections in a sustained deflationary cycle are to hold onto your job, have as little debt as possible, save as much money as possible, defer discretionary purchases until prices drop, and sell assets you don’t need while they still have value.

Reviewed by Charlene Rhinehart

Call Deposit vs. Time Deposit Accounts: An Overview

For most people, a bank account is simply a place to hold money, not make money. Yet there are several types of bank accounts, so consumers should know which ones best fit their needs.

A lot of people understand the two major types of bank accounts: savings accounts, which allow easy access and earn modest interest, and checking accounts, which are used for day-to-day cash needs and pay little or no interest.

Those accounts are fine for starters, but there are other types of accounts that allow customers to earn higher interest in exchange for less access to their cash. These are called time deposit accounts and call deposit accounts, which are similar but have some key differences.

Key Takeaways

• Savings and checking accounts are the most basic banking accounts, but other types of accounts allow customers to earn higher interest in exchange for less access to their cash.
• Call deposits are accounts that require a minimum balance in exchange for a higher interest rate.
• With call deposits, unlike time deposits, you have ready access to most of your cash, yet are still able to earn a higher return.
• Time deposits, also known as certificates of deposit (CDs), pay a much higher interest rate but require minimum deposits for a set time period—anywhere from six months to 30 years—with interest generally rising the longer you agree to go without your money.
• At least in the United States, the most popular time deposits have historically been for one, two, or five years.

Call Deposits

Call deposits are basically accounts that require you to keep a minimum balance in exchange for a higher interest rate. Unlike time deposits, you have ready access to most of your cash, yet are still able to earn a higher return.

Banks have been marketing these types of accounts for years, often calling them Checking Plus or Advantage Accounts. It’s an attempt to offer the consumer the best of both worlds—easy access plus higher interest than they would get with a regular checking or savings account.

One advantage of call deposits is that they can be denominated in different currencies. For a South African who wants to minimize her rand holdings while capitalizing on the relative stability of the pound sterling or U.S. dollar, a call deposit is a way to do so without being subjected to giant transaction costs with every deposit or withdrawal.

Banks offer time and call deposit accounts simply to attract more depositors. Since banks make money by making loans, the more money they have on deposit, the more loans they can make. For banks, offering a slightly higher interest rate in return for a more stable cash flow makes sense.

Time Deposits

Time deposits, also known as certificates of deposit (CDs), pay a much higher interest rate but require a minimum deposit and tie your money up for a set period of time, which can range anywhere from six months to 30 years (with interest rising the longer you agree to go without your money).

At least in the United States, the most popular time deposits have historically been for one, two, or five years. Beyond that duration, your money has greater potential for growth via an investment account. Time deposit/CD rates fluctuate largely in step with the prime lending rate, which is itself a function of the federal funds rate set by the Federal Reserve Board.

Time deposits are known by different names in other countries. In Canada, for example, they are called a term deposit; in Ireland, it’s a fixed-term account; and in the United Kingdom, it’s a savings bond (which is different from the United States’ debt security of the same name).

Note

Time deposits are known by different names in other countries. In Canada, for example, they are called term deposits; in Ireland, fixed-term accounts; and in the United Kingdom, savings bonds.

Key Differences

Deciding which account is better is simply a matter of your objective. If you want ready access to your money, a call deposit is probably a better choice. But if you have excess cash that you don’t think you’ll need for a while, a time deposit may offer a higher return and be the best choice.

The beauty of a time deposit is that it’s among the surest things in all of personal finance. Hidden costs are virtually nonexistent, happening only in the rarest of cases.

For instance, lending institutions will reserve the right to shorten the term at their discretion, not that they ever do. See the deposit to term, as it were, and you’ll enjoy your money back, with interest. Withdraw early, though, and you’ll be subject to penalties.

In practice, time deposits are used by investors (individuals, businesses, etc.) that are looking for safe storage. For that, they sacrifice liquidity—or more accurately, liquidity beyond a certain level. Everyone needs some readily accessible cash. Once you’re past the point where having that cash is not a problem, only then should you examine time and call deposits.

What Is a Bank Account?

A bank account is a financial arrangement where a customer’s assets are held by a financial institution. Bank accounts allow customers to deposit and withdraw funds.

What Is a Call Deposit Account?

A call deposit account is a bank account for investment funds that offers the advantages of both a savings and a checking account. It offers higher interest rates than some money market accounts and a guaranteed level of liquidity.

What Is a Time Deposit Account?

A time deposit account is an interest-bearing bank account that has a preset date of maturity, such as a certificate of deposit (CD). The money must be held in the account for the fixed term to receive the stated interest rate in full.

The Bottom Line

Time deposit accounts and call deposit accounts allow customers to earn higher interest in exchange for less access to their cash. They are similar but have some key differences.

Call deposit accounts require a minimum balance in exchange for a higher interest rate. You have ready access to most of your cash, but are still able to earn a higher return.

Time deposit accounts, also known as certificates of deposit (CDs), pay a much higher interest rate but require minimum deposits for a set time period—from six months to 30 years—with interest generally rising the longer you go without your money.

Reviewed by Erika Rasure
Fact checked by Kirsten Rohrs Schmitt

When your child turns 18, the experience can be an emotional one. Adulthood suddenly becomes real. It happens a lot sooner than you probably were expecting, especially if your child is still a dependent.

In addition to the emotional aspects, you’ll both come face to face with certain legal realities. Specifically, your rights as a parent diminish when your child turns 18, including the right to know anything about their finances, medical condition, or school records. That means, for example, that if your child were injured, you wouldn’t have the right to make medical decisions on their behalf. 

If you want this to change, you’ll need to have certain legal paperwork in place—and your child will need to agree.

Key Takeaways

• When your child turns 18, they are considered by law to be an adult. Unless you have filed the appropriate legal paperwork, you will not be entitled to information about their finances, health, or education.
• Anyone over 18 must give written permission for another adult to receive medical information about them, even if the other adult is their parent.
• A medical power of attorney (POA) lets you make decisions about another adult’s health if they become incapacitated, while a durable POA allows you to make business decisions for that person.
• A living will gives you the authorization to make decisions for another adult about life-extending medical treatment and organ donations.

FERPA Release

Under the Family Educational Rights and Privacy Act (FERPA), students age 18 or older must provide written consent before education records such as grades, transcripts, and disciplinary records can be shared with parents. This law applies to students who attend a school that receives any funding from the U.S. Department of Education.

Most public high schools, as well as public and private colleges and universities, notify parents about this requirement. If you want access to your child’s records, make sure to ask them to sign a release.

Important

In most cases, legal documents must be signed, witnessed, and notarized.

HIPAA Authorization

Commonly called HIPAA, the Health Insurance Portability and Accountability Act prevents anyone not named in a signed release from receiving medical information about another adult.

Your son or daughter can sign a full release or set limits on what information may be shared.

You should have the signed authorization in your possession so you can show it to any doctor, hospital, or other medical providers as needed.

Medical Power of Attorney

A medical power of attorney—sometimes called a healthcare power of attorney or a healthcare proxy—is another document you need when your child turns 18. It is also sometimes called a durable power of attorney for healthcare (as opposed to just a durable power of attorney, which pertains only to business issues). All those designations refer to a document that gives you the ability to make decisions about your child’s healthcare.

Typically, the medical power of attorney doesn’t become active unless your child is physically or mentally incapable of making their own medical decisions—although each state has its own criteria, including whether the document must be witnessed or notarized.

A medical power of attorney is not the same as a living will.

Living Will

A living will, also known as an advance directive, addresses such things as your child’s wishes regarding life-extending medical treatment and organ donations. Having this document in place can help avoid the potential pain and anguish of different family members being at odds about how to handle a tragedy, such as an automobile accident.

Durable Power of Attorney

Children can also grant their parents a durable power of attorney to handle business for them in the event they become incapacitated, if they are simply out of the country (say, studying abroad) or if, for some other reason, they need you to assist with their affairs. A durable power of attorney allows you to access bank accounts, sign tax returns, renew car registration, and perform other transactions.

Your child can restrict the types of transactions you can perform or grant full access and also grant the power of attorney with a timeline including a starting and stop date.

Financial Records Access

If your child is away at school and all you really want is access to tuition and housing accounts, many colleges allow students to grant such access to parents without the hassle of a power of attorney. Of course, any joint accounts that you and your child share are open to you without special permission.

Why Is 18 Years a Special Age?

At age 18, an individual has reached the age of majority: they are no longer a minor. They can enter into legal contracts. They can be tried as an adult if they are charged with a crime. Their parents or guardians are no longer legally obligated to take care of them. They can also vote.

What Is a Dependent?

A dependent is a status that is claimed on a tax return. It identifies a person’s relationship for the Internal Revenue Service (IRS).

When You Turn 18 Are You No Longer a Dependent?

If an individual is a full-time student who is younger than 24 years old, they may still be claimed as a dependent for tax purposes. Otherwise, the cut-off is age 19.

The Bottom Line

Most of the documents you need when a child turns 18 can be created without hiring a lawyer, although some people choose to involve an attorney to make sure the paperwork is completely accurate. Either way, it’s important to sit down with your child before you ask them to sign anything. Discuss the reason for the document or form, consider your child’s concerns and, in general, treat them like the adult they have now become. After all, their reaching adulthood is the reason why these documents are necessary.