Depreciation

Published Dec 27, 2022

Definition of Depreciation

Depreciation is defined as the gradual decrease in the value of an asset over time due to wear and tear, obsolescence, or other factors. That means it is an accounting method used to spread the cost of an asset over its useful life.

Example

To illustrate this, let’s look at an example. Imagine you own a car that you bought for USD 20,000. After five years, the car is worth USD 10,000 due to wear and tear. In this case, the car has depreciated by USD 10,000 over the five-year period.

To calculate the depreciation expense for the car, you need to divide the USD 10,000 by the five-year period. That means the depreciation expense for the car is USD 2,000 per year. This amount is then deducted from the car’s value each year to arrive at the car’s book value.

Why Depreciation Matters

Depreciation is an important concept for businesses, as it allows them to spread the cost of an asset over its useful life. This helps businesses to manage their cash flow more effectively, as they can deduct the depreciation expense from their taxable income. In addition, it also helps businesses to accurately reflect the value of their assets on their balance sheet.