HOMEPAGE

Depreciation

Definition

Depreciation is the systematic allocation of the cost of a tangible long‑term asset over its useful life. Instead of expensing the full cost upfront, companies spread the expense across the periods in which the asset provides economic benefit.

Why It Matters

• Matches the cost of an asset with the revenue it helps generate (matching principle).
• Reduces taxable income by recognizing wear‑and‑tear as an expense.
• Helps investors understand how capital‑intensive a business is.
• Affects profitability metrics such as operating income and EBITDA.

Common Depreciation Methods

• Straight‑Line Depreciation: Spreads cost evenly over the asset’s useful life.
• Declining Balance: Accelerates depreciation, expensing more in early years.
• Units of Production: Based on usage rather than time.

Key Concepts

• Useful Life: Estimated period the asset will generate value.
• Salvage Value: Expected value at the end of its useful life.
• Depreciable Base:

$$\text{Depreciable Base}=\text{Cost}-\text{Salvage Value}$$

Example

A company buys equipment for $50,000 with a useful life of 5 years and a salvage value of $5,000.

$$\text{Depreciable Base}=50,000-5,000=45,000$$

Using straight‑line depreciation:

$$\text{Annual Depreciation}=\frac{45,000}{5}=9,000$$

The company records $9,000 in depreciation expense each year.