What Is Depreciation?
Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. It represents how much of an asset's value has been used up over time.
Why Depreciation Matters
Businesses use depreciation to match the expense of an asset with the revenue it generates. This helps provide a more accurate picture of profitability and supports tax deductions.
Common Depreciation Methods
- Straight-Line Method: Equal depreciation expense each year.
- Declining Balance Method: Higher depreciation in early years.
- Units of Production: Based on actual usage or output.
Example: Straight-Line Depreciation
If a company buys a machine for $10,000 with a salvage value of $1,000 and a useful life of 5 years:
Annual Depreciation = (Cost − Salvage Value) ÷ Useful Life
= ($10,000 − $1,000) ÷ 5 = $1,800 per year