Depreciation
The systematic allocation of a tangible asset's cost over its useful life as an accounting expense.
What is Depreciation?
Depreciation is the accounting process of allocating the cost of a tangible fixed asset over its estimated useful life, reflecting the asset's consumption, wear, and obsolescence. Rather than expensing the full asset cost when purchased, companies spread the cost over the periods during which the asset generates revenues — matching the expense to the benefit. Common depreciation methods include straight-line (equal expense each year), declining balance (larger expenses early), and units-of-production (based on actual use). For tax purposes, the IRS provides its own depreciation schedules (MACRS). Depreciation is a non-cash expense: it reduces reported earnings and taxable income but does not require an actual cash outflow in the period recorded.
Example
A manufacturer buys a machine for $500,000 with a 10-year useful life and $50,000 salvage value. Using straight-line depreciation: annual expense = ($500,000 - $50,000) / 10 = $45,000/year. Over 10 years, the machine is fully depreciated to its $50,000 salvage value. The $45,000 annual expense reduces pre-tax income each year, lowering tax liability — but the company's cash account was only debited when the machine was purchased.