What is depreciation?
When a business buys a long-lasting asset such as a computer, vehicle or machine, it doesn't expense the full cost immediately. Depreciation spreads the cost over the years the asset is used, matching the expense to the revenue it helps generate.
Key inputs
- Cost: purchase price plus costs to get the asset ready for use
- [Useful life](/glossary/useful-life): how long the business expects to use it
- Residual value: expected value at the end of its life
Common methods
- [Straight-line](/glossary/straight-line-depreciation): (Cost − Residual value) ÷ Useful life, the same charge every year.
- Declining balance: a fixed percentage of the remaining book value, with higher charges early on.
- Units of production: based on usage, such as machine hours or miles.
Example
A $12,000 laptop fleet with a three-year life and no residual value is depreciated by $4,000 a year under straight-line. Each year: debit depreciation expense $4,000, credit [accumulated depreciation](/glossary/accumulated-depreciation) $4,000.
Accounting vs tax depreciation
Tax rules often set their own rates (capital allowances or MACRS, for example), which can differ from accounting depreciation and create [deferred tax](/glossary/accounting-for-income-taxes).
Why it matters
Depreciation affects profit, asset values and tax. It is a non-cash expense, so it is added back in the [cash flow statement](/glossary/cash-flow-statement) and in [EBITDA](/glossary/ebitda).