Depreciation (Accounting)

Depreciation is an accounting method that spreads the cost of a tangible asset (like equipment, buildings, or vehicles) over its estimated useful life. Instead of expensing the full cost when purchased, the company records a portion each year as a depreciation expense on the income statement while reducing the asset's book value on the balance sheet. This process matches the cost of the asset with the revenue it helps generate over time.

There are several depreciation methods. Straight-line depreciation divides the cost evenly across the useful life — a $100,000 machine with a 10-year life generates $10,000 in annual depreciation. Accelerated methods like double-declining balance or MACRS (Modified Accelerated Cost Recovery System, used for tax purposes) front-load depreciation, creating larger expenses in early years. Companies may use one method for financial reporting and another for tax filing, creating timing differences between book income and taxable income.

For investors, depreciation is crucial because it's a non-cash charge — no cash actually leaves the company when depreciation is recorded. This is why depreciation is added back to net income when calculating operating cash flow. However, depreciation does represent real economic cost — assets do wear out and eventually need replacement. This is why comparing CapEx to depreciation matters: if CapEx consistently equals depreciation, the company is merely maintaining its asset base; if CapEx exceeds depreciation, it's investing for growth. EBITDA strips out depreciation to show operating performance before capital allocation decisions, but critics argue this ignores the very real cost of capital consumption.