Depreciation: What Is It?

Depreciation is the financial world’s way of admitting a simple truth: stuff gets older.
Trucks get tired. Laptops become “vintage” in roughly 14 minutes. Even the nicest office chair eventually starts squeaking like it’s auditioning for a horror movie.

In accounting terms, depreciation is a method of spreading the cost of a tangible asset
(think equipment, vehicles, machinery, furniture, buildingsminus the land) over the years you use it. Instead of taking one giant expense the day you buy the asset,
depreciation lets you recognize that cost gradually, in a way that matches how the asset helps you earn revenue.

Depreciation, in plain English

If your business buys a $60,000 delivery van and uses it for five years, it wouldn’t make much sense to report a $60,000 expense in Year 1 and then pretend the van is “free” in Years 2–5.
Depreciation fixes that by allocating the cost over the van’s useful life.

The big idea

Depreciation is an allocation of cost over timenot a magical crystal ball predicting what you could sell the asset for tomorrow.
Market value can go up or down. Depreciation is about systematically recognizing the cost of using the asset.

Why depreciation exists (and why your accountant cares so much)

Depreciation helps financial statements tell a more realistic story. It supports the “matching” concept: when an asset helps generate revenue across multiple periods,
its cost should show up across those same periods.

• It smooths expenses: avoids one-year “expense whiplash” right after a big purchase.
• It improves comparability: makes Year 1 and Year 2 financials easier to compare.
• It supports planning: helps management understand how quickly assets are being “consumed” by operations.
• It matters for taxes: tax depreciation rules can reduce taxable income (with their own special rulebook).

Where depreciation shows up on financial statements

Income statement

Depreciation appears as an expense (often in operating expenses or included in cost of goods sold for production equipment).
It reduces reported profiteven though it usually doesn’t require a cash payment in that same period.

Balance sheet

The asset remains on the books at cost, and you track a running total called accumulated depreciation.
Subtract accumulated depreciation from the asset’s cost to get net book value (also called carrying value).

Cash flow statement

Because depreciation is typically a non-cash expense, it’s commonly added back in the operating section when reconciling net income to operating cash flow.
That’s why depreciation can lower accounting profit without draining the bank account that same day.

The key terms you’ll hear (and what they actually mean)

Cost (or basis)

The amount you paid to acquire the asset, including many necessary costs to get it ready for use (like delivery, installation, or setup).

Useful life

How long you expect the asset to be productive for your business. This is an estimatenot an expiration date stamped by the universe.

Salvage value (residual value)

What you expect the asset will be worth at the end of its useful life (resale, trade-in, scrap). In many real-life business settings, salvage value is smallor treated as zerodepending on policy and practicality.

Depreciable basis

The portion of the asset’s cost you’ll depreciate. For many assets, it’s cost minus salvage value.
For real estate, the land portion is generally not depreciatedonly the building and eligible improvements.

Accumulated depreciation

The total depreciation recorded to date for an asset. Think of it as the “how much cost we’ve already allocated” scoreboard.

Net book value

Cost minus accumulated depreciation. It’s an accounting carrying amount, not necessarily what you could sell the asset for.

Common depreciation methods (the “how” part)

Different depreciation methods exist because assets don’t all wear out in the same pattern.
Some lose usefulness evenly over time. Others do most of their heavy lifting early and slow down later.

1) Straight-line depreciation

The classic. The reliable. The “I just want my spreadsheet to stop yelling at me” method.
You depreciate the same amount each year.

Formula: (Cost − Salvage Value) ÷ Useful Life

Example

You buy a $10,000 commercial printer. You expect to sell it for $1,000 after five years.

• Depreciable amount = $10,000 − $1,000 = $9,000
• Annual depreciation = $9,000 ÷ 5 = $1,800 per year

2) Declining balance methods (including double-declining)

These record more depreciation early and less lateruseful when assets lose value or usefulness faster at the beginning.
A common version is double-declining balance (DDB).

DDB typically uses 2× the straight-line rate applied to the asset’s beginning book value each year.
It’s faster, more aggressive, and great for assets that become obsolete quickly (hello, technology).

3) Sum-of-the-years’ digits (SYD)

Another accelerated method. It front-loads depreciation using a fraction that decreases each year.
It’s like declining balance’s cousin who still brings a calculator to parties.

4) Units-of-production (or usage-based depreciation)

This one ties depreciation to output or usageperfect for machines where wear depends on how much you run them.

Example: A manufacturing press rated for 1,000,000 units. If you produce 120,000 units this year, you record 12% of the depreciable cost.

Depreciation in taxes vs. depreciation in your books

Here’s where people get confusedand where tax professionals earn their coffee.
Book depreciation (financial statements) aims to represent economic reality.
Tax depreciation follows tax law, which may intentionally speed up deductions to encourage investment.

Tax depreciation: MACRS, Section 179, and bonus depreciation (high-level)

In the U.S., many business assets are depreciated for tax using systems like MACRS (Modified Accelerated Cost Recovery System),
which assigns asset classes and recovery periods. There are also special elections and ruleslike Section 179 expensing for certain assets,
and bonus depreciation in certain yearseach with eligibility requirements and limits.

The takeaway: your tax depreciation schedule can look very different from your financial reporting depreciation schedule,
and that difference can create deferred tax items in more formal reporting environments.

Rental property depreciation (a classic example)

For many U.S. tax situations, residential rental buildings are depreciated over a long recovery period (commonly 27.5 years under general rules),
and the land portion is not depreciated. That’s why real estate investors spend time allocating purchase price between land and building.

Important note: This article is educational, not tax advice. Tax rules depend on facts, dates, property type, and electionsso use a qualified tax pro for decisions.

Depreciation vs. amortization vs. depletion

These terms are siblings, not twins:

• Depreciation: tangible assets (equipment, vehicles, buildings).
• Amortization: intangible assets (certain software, patents, trademarks, customer listsdepending on classification and rules).
• Depletion: natural resources (timber, oil, minerals), where the “asset” is literally extracted from the earth.

What depreciation is not (and why that matters)

Depreciation is not “what it’s worth today”

You might have a vehicle that’s fully depreciated on the books but could still be sold for real money.
Conversely, an asset might have a high book value but be practically unsellable if it’s outdated.

Depreciation is not a cash payment

Depreciation usually doesn’t involve writing a check each year. You paid cash (or took on financing) when you bought the asset.
Depreciation is the accounting recognition of that cost over time.

A practical walkthrough: depreciation from purchase to year-end

Let’s say a small business buys a $25,000 delivery vehicle and expects:

• Useful life: 5 years
• Salvage value: $5,000
• Method: straight-line

Step 1: Calculate depreciable amount

$25,000 − $5,000 = $20,000

Step 2: Compute annual depreciation

$20,000 ÷ 5 = $4,000 per year

Step 3: Record the journal entry (typical format)

• Debit: Depreciation Expense $4,000
• Credit: Accumulated Depreciation $4,000

After one year, the balance sheet shows the vehicle at cost ($25,000), less accumulated depreciation ($4,000),
for a net book value of $21,000.

Common mistakes (and how to avoid them)

Mistake 1: Depreciating land

Land generally doesn’t wear out the way buildings do, so it’s usually excluded from depreciation calculations.
If you buy property, separate land vs. building in your records.

Mistake 2: Forgetting “placed in service” timing

Depreciation generally starts when an asset is ready and available for usenot necessarily the day you signed the invoice.
Timing can affect both financial reporting and tax calculations.

Mistake 3: Never revisiting useful life estimates

If your operations change (new tech, heavier usage, different maintenance patterns), useful life assumptions may need updating.
Accounting isn’t set-it-and-forget-itmore like set-it-and-reconcile-it.

Mistake 4: Confusing repair vs. improvement

Routine repairs are typically expensed. Improvements that extend life or significantly increase value may be capitalized and depreciated.
This distinction affects profits and taxesso document what you did and why.

How depreciation affects business decisions

Depreciation may look like a “paper expense,” but it can influence real decisions:

• Pricing: Knowing the cost of equipment usage helps set profitable prices.
• CapEx planning: Depreciation schedules signal when assets are nearing end-of-life.
• Profit analysis: Depreciation impacts net income and ratios like ROA.
• Performance metrics: Some leaders look at EBITDA to reduce the noise from depreciationuseful, but not the whole story.

Bottom line

Depreciation is the accounting tool that turns a big, upfront purchase into a series of smaller, more realistic expenses over time.
It helps financial statements reflect how assets support revenue generation across periodswithout pretending your tools, vehicles, and equipment are immortal.

If you remember one thing, make it this: depreciation is about systematic cost allocation.
It’s not a resale estimate, it’s not a cash drain each year, and it’s definitely not an excuse to keep using a printer that jams every third page.

Experiences people have with depreciation (real-world stories and lessons)

If you’ve ever watched a brand-new gadget become “last season” before you finish peeling off the protective film, you already understand depreciation emotionally.
In practice, depreciation shows up in surprisingly human momentsespecially when you’re running a business, managing rentals, or even just trying to make sense of your numbers without developing an eye twitch.

One common experience: the “I bought it, why isn’t it an expense?” moment. New business owners often assume that if cash left the bank account, it must be an immediate expense.
Then they learn that equipment purchases are usually capitalized and depreciated, and suddenly their bookkeeping feels like it’s speaking a new dialect.
The upside is that depreciation makes profit trends look more stable. The downside is that it can feel like your financial statements are calmly disagreeing with your checking account.

Another frequent story is the “fully depreciated but still working” surprise. Businesses that keep vehicles or machines longer than expected sometimes see assets hit a net book value near zero,
yet they’re still productive every day. Owners ask, “So… do I get to expense it again?” (No.) What you do get is a reminder that book value isn’t market value and isn’t usefulness either.
That old forklift might be ugly, but it’s loyallike a dog that sheds everywhere but always shows up for you.

Landlords have their own depreciation rite of passage: realizing they can’t depreciate the land, only the building and qualifying improvements.
The first time someone explains “allocate between land and structure,” it can feel oddly philosophicallike you’re negotiating with dirt.
Once it clicks, it becomes a practical habit: keep closing statements, document improvements, and track what’s a repair versus what’s a capital improvement.
The experience tends to teach one big lesson: good records are not “extra,” they’re the difference between confident reporting and frantic spreadsheet archaeology.

Then there’s the “tax depreciation vs. book depreciation” whiplash. People often see one depreciation number on their financial statements,
a different one on the tax return, and assume something is broken. What’s really happening is that tax rules can accelerate deductions,
while financial reporting aims for a steady, realistic pattern of cost allocation. The lived experience here is less about math and more about communication:
owners learn to ask better questions like, “What’s driving the difference?” and “How does that affect taxable income versus reported profit?”

Finally, depreciation shows up in decision-making: “Should I repair this machine or replace it?” “Is leasing smarter than buying?” “Can I afford an upgrade?”
Even if depreciation is non-cash, it helps you see the true cost of using assets over time. The people who get the most value from depreciation aren’t obsessed with the journal entries
they’re the ones who use depreciation insights to plan upgrades, budget realistically, and avoid getting ambushed by aging equipment.
In other words, depreciation isn’t just an accounting rule. It’s a way to keep your business from being surprised by reality.