Depreciation
The systematic allocation of a tangible asset's cost over its useful life.
Depreciation spreads the cost of a tangible fixed asset (equipment, vehicles, buildings, furniture) over the years it's expected to be used, rather than recording the entire cost in the year of purchase.
The most common methods are straight-line (equal annual amounts), declining balance (larger amounts in early years), and units-of-production (based on actual usage). Straight-line is the most widely used due to its simplicity.
Depreciation is a non-cash expense — it appears on the P&L and reduces reported profit, but no actual cash leaves the business. This is why EBITDA (which adds back depreciation) is often used as a proxy for cash profitability.
For tax purposes, many jurisdictions offer accelerated depreciation or capital allowances that differ from accounting depreciation. This creates temporary differences between tax and financial reporting — a concept central to deferred tax accounting.
Companies with significant fixed assets — manufacturing, logistics, real estate — must carefully estimate useful lives and residual values. Getting these wrong affects profitability, asset values, and potentially loan covenants that reference financial ratios.
Related Terms
The gradual write-off of an intangible asset's cost, or the scheduled repayment of a loan principal.
Earnings Before Interest, Taxes, Depreciation, and Amortization — a measure of operating profitability.
Spending on long-term assets like equipment, property, or technology that benefits the business over multiple years.
A snapshot of a company's assets, liabilities, and equity at a specific point in time.