Depreciation

Definition

In accounting, depreciation is a way of spreading the cost of a physical asset over its useful life. Instead of recording the entire expense at once when the asset is bought, businesses gradually reduce its value each year. This approach helps match the asset’s cost with the revenue it generates.

There are a few methods to calculate depreciation:

• Straight-line depreciation: It spreads the cost evenly over the asset’s lifespan;
• Double-declining balance: It front-loads the expense, making it higher in the early years when the asset is most productive. 

Why it matters

Depreciation keeps financial records aligned with the reality of asset use over time. When a business buys something big, depreciation spreads that cost across the asset’s useful life, so each year’s financial records only reflect part of the asset's expense. 

Beyond just tracking value, depreciation also matters for tax purposes. Since each year's depreciation counts as an expense, it lowers taxable income without needing an actual cash outflow each year.