Accounting
Depreciation
Spreading the cost of a long-lasting asset across the years it's actually used, instead of counting the whole cost as an expense the moment it's purchased.
Definition
Depreciationis the accounting practice of spreading the cost of a long-lasting asset — equipment, a vehicle, a building — across the years it's expected to be useful, recording a portion of that cost as an expense in each of those years, rather than recording the entire cost as an expense in the single year it was purchased.
Why this exists
Per Accrual vs. Cash Accounting, the income statement is meant to reflect what a business actually did during a specific period, not just when cash happened to move. A long-lasting asset like an oven, a delivery van, or a building doesn't get "used up" the moment it's purchased — it keeps generating value for years afterward. If the entire cost were expensed in the year of purchase, that year would look artificially unprofitable (one huge expense), and every following year the asset is still being used would look artificially more profitable than it really is, because none of the asset's cost shows up as an expense in those later years even though the asset is still doing real work.
Depreciation exists to fix that mismatch, by spreading the asset's cost across the years it's actually expected to be useful, so each year's income statement carries a fair share of the cost alongside the revenue that asset helped generate. It's the same underlying idea as matching revenue and expenses to the period they belong in — depreciation just applies it to costs that pay off over many years instead of one.
Depreciation is also a purely accounting entry, not a cash payment — the cash for the asset was already spent, in full, back when it was purchased (it shows up as investing activity on the cash flow statement in the year of purchase). Each year's depreciation expense on the income statement doesn't cost the business any additional cash; it just recognizes, on paper, that a portion of an already-spent cost belongs to that year.
Formula & mechanics
The simplest method, straight-line depreciation:
Annual depreciation = (Cost − Salvage value) / Useful life (years)
Salvage valueis what the asset might still be worth — for resale or parts — at the end of its useful life; many simple examples just assume it's zero.
Straight-line isn't the only method. Declining balance depreciation — sometimes called accelerateddepreciation — applies a fixed rate to whatever book value is left each year instead of spreading the cost evenly, so it recognizes more expense in the early years of an asset's life and less in the later years. This better matches assets that lose usefulness faster early on (like vehicles or technology), and some tax rules favor it because front-loading the expense reduces taxable income sooner. Either method spreads the exact same total cost — they just disagree on when within the asset's life that cost gets recognized.
Worked example
Recall Maria's $6,000 oven from The Accounting Equation. Suppose it has a useful life of 10 years and no expected salvage value.
Annual depreciation = ($6,000 − $0) / 10 = $600 per year
Each year for 10 years, the bakery's income statement records a $600 depreciation expense tied to the oven, alongside that year's revenue and other costs — even though the full $6,000 in cash was spent back in year one, when the oven was bought.
Try it yourself
Straight-line: annual expense
$600.00
every year for 10 years
Declining balance: year 1 expense
$1,200.00
Declining balance: total expensed
$5,355.75
How the math works
Straight-line spreads the cost evenly: $6,000.00 − $0.00 salvage, divided by 10 years, is $600.00 every year. Declining balance instead applies a fixed rate to whatever book value is left, front-loading the expense:
Year Straight-line Declining balance SL book value DB book value 1 $600.00 $1,200.00 $5,400.00 $4,800.00 2 $600.00 $960.00 $4,800.00 $3,840.00 3 $600.00 $768.00 $4,200.00 $3,072.00 4 $600.00 $614.40 $3,600.00 $2,457.60 5 $600.00 $491.52 $3,000.00 $1,966.08 6 $600.00 $393.22 $2,400.00 $1,572.86 7 $600.00 $314.57 $1,800.00 $1,258.29 8 $600.00 $251.66 $1,200.00 $1,006.63 9 $600.00 $201.33 $600.00 $805.31 10 $600.00 $161.06 $0.00 $644.25
Both methods expense the same total amount over the asset's life ($6,000.00) — declining balance just recognizes more of it in the earlier years and less in the later years, instead of spreading it evenly.
Common misconceptions
“Depreciation means the asset is literally losing value or breaking down at that specific rate.”
Depreciation is an accounting estimate of cost allocation, not a real-time measure of the asset's actual physical condition or resale value — the two can diverge quite a bit.
“Depreciation expense is a cash cost each year.”
The cash was spent when the asset was purchased. Each year's depreciation is a non-cash accounting entry that spreads that already-spent cost across the income statement, not a new cash outflow.
“All assets get depreciated.”
Assets expected to last indefinitely or that aren't consumed by use over time — most notably land — typically aren't depreciated at all, only assets with a limited useful life.
Also in the Glossary: Declining-Balance Depreciation, Depreciation, Salvage Value, Straight-Line Depreciation