Depreciation
Definition
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life, reflecting the asset's gradual wear and tear, obsolescence, or decline in value.
Explanation
Depreciation allows businesses to spread the cost of major assets over their useful lives, matching the expense with the revenue the asset generates. Common methods include straight-line (equal annual amounts), declining balance (higher early years), and units of production (based on usage).
Depreciation is a non-cash expense that reduces taxable income and reported earnings. It's important for tax planning and for accurately representing asset values on the balance sheet.
Example
A company buys a delivery truck for $50,000 with a 5-year useful life. Using straight-line depreciation, the annual depreciation expense is $10,000 per year.