Depreciation

What Is Depreciation?

When your business buys a physical asset that will last several years, such as a company vehicle, office furniture, or machinery, you do not expense the entire cost at once. Instead, you recognize a portion of the cost each year through depreciation. The most common method is straight-line depreciation, which spreads the cost evenly over the asset's useful life.

For example, if you buy a delivery van for $40,000 with an expected useful life of five years and no salvage value, straight-line depreciation would be $8,000 per year.

Why It Matters for Your Business

Depreciation affects your profitability calculations, tax obligations, and understanding of asset value.

• Tax deductions: Depreciation is a non-cash expense that reduces your taxable income. You do not write a check for depreciation, but it lowers the profit on which you are taxed.
• Accurate profitability: By matching the cost of an asset to the revenue it helps generate, depreciation ensures your income statement reflects the real economics of your business.
• Asset management: Tracking depreciation helps you know when assets are nearing the end of their useful life and when replacement planning should begin.

Different depreciation methods (straight-line, declining balance, units of production) suit different situations. A piece of equipment that loses value quickly might warrant accelerated depreciation, while a building might use straight-line over 30 years.