Depreciation is the systematic allocation of a tangible asset’s cost over its useful life.
A 30,000 expense in year one — it’s a $6,000 expense each year under straight-line depreciation. This matches the cost to the periods that benefit from the asset, which is the same matching principle that drives accrual accounting. Without depreciation, the year of purchase would absorb the full cost and every subsequent year would show an artificially low expense, distorting both periods.
Three common methods determine how the cost spreads across periods. Straight-line depreciation divides the cost evenly (minus any salvage value) over the asset’s useful life — simple and widely used. Declining balance depreciation front-loads the expense, recognizing more depreciation in early years when the asset is newer and arguably more productive. Units-of-production depreciation ties the expense to actual usage, making it useful for assets like machinery where wear correlates with output rather than time [citation needed].
Depreciation is a non-cash expense. No money moves when it’s recorded — the cash left the entity when it bought the asset. This is why the cash flow statement adds depreciation back to net income when calculating operating cash flow: the income statement deducted it as an expense, but it didn’t reduce cash in the period.
Related terms
- Account — depreciation involves both an expense account and a contra-asset account (accumulated depreciation).
- Accrual accounting — the framework that requires spreading cost over time rather than expensing it all at purchase.
- Income statement — where depreciation expense appears, reducing reported profit.
- Cash flow statement — where depreciation is added back because it’s a non-cash charge.