Depreciation

In business, depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. Instead of expensing the full cost of an asset (like equipment or a building) in the year it was purchased, depreciation spreads that cost out over the years the asset is expected to be used to generate revenue. It reflects the asset's wear and tear or obsolescence over time.

Depreciation in business refers to recognizing the expense of using an asset over time. It's a non-cash expense that appears on the income statement and reduces the book value of the asset on the balance sheet. It aligns the cost of an asset with the revenue it helps generate, following the matching principle in accounting.

The Straight-Line Depreciation method is one of the simplest and most commonly used methods in business and for financial reporting. It allocates an equal amount of depreciation expense to each year of the asset's useful life.

Formula: (Cost of Asset - Salvage Value) ÷ Useful Life (in years)

For tax purposes in many countries (like the U.S.), the Modified Accelerated Cost Recovery System (MACRS) is the required method, which often results in faster depreciation than straight-line in the earlier years.

Generally, tangible assets used in a business for more than one year that lose value over time can be depreciated. Common examples include:

• Buildings (not land)
• Machinery and Equipment
• Vehicles (cars, trucks, etc.)
• Furniture and Fixtures
• Computer Hardware
• Improvements to property

Assets that cannot be depreciated include land, inventory, and intangible assets (like patents or copyrights, which are amortized instead).

Depreciation is important for several reasons:

• **Accurate Financial Reporting:** It helps match the expense of using an asset with the revenue it helps generate over time, giving a more accurate picture of periodic profitability.
• **Tax Benefits:** Depreciation expense is tax-deductible, reducing a business's taxable income and therefore its tax liability.
• **Asset Valuation:** It systematically reduces the book value of an asset on the balance sheet, reflecting its declining value.
• **Cash Flow:** While a non-cash expense, the tax savings from depreciation improve a business's cash flow.