Depreciation

The spreading of a long-lived asset's cost over the years it is used, recorded as a non-cash expense.

DefinitionThe spreading of a long-lived asset's cost over the years it is used, recorded as a non-cash expense.

Depreciation allocates the cost of a physical asset, such as equipment, vehicles or buildings, across its useful life. Instead of expensing a $50,000 machine in the year it is bought, the business records part of the cost each year it produces value. The cash leaves when the asset is bought; depreciation is the accounting charge that follows.

How it is computed

Straight-line depreciation = (cost − salvage value) / useful life in years. Accelerated methods charge more in early years; the total over the asset's life is the same.

Example

A machine costs $50,000, has an expected salvage value of $5,000 and a useful life of five years. Annual depreciation is ($50,000 − $5,000) / 5 = $9,000, and its book value after two years is $50,000 − $18,000 = $32,000.

Where it goes wrong

Mistaking it for cash: profit falls by $9,000 a year but no cash moves. Useful lives set too long also flatter profit, and tax depreciation often differs from book depreciation. For how it follows capital spending, see opex vs capex.

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