What Is Depreciation?
Depreciation is how accountants spread the cost of a fixed asset — like machinery, vehicles, or buildings — across the years it's used, instead of expensing it all at once. It matches the cost of an asset to the revenue it helps produce and lowers taxable income.
Depreciation is the systematic allocation of an asset's cost over its useful life. Under the straight-line method: Depreciation Expense = (Cost − Salvage Value) / Useful Life.
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Step-by-step worked examples
A company buys a delivery van for $20,000 with an estimated salvage value of $2,000 and a useful life of 5 years. Find the annual depreciation expense.
D = (C − S) / n D = (20,000 − 2,000) / 5 D = 18,000 / 5 = $3,600 per year
A factory machine costs $50,000, has a salvage value of $5,000, and a useful life of 10 years. Calculate annual depreciation.
D = (C − S) / n D = (50,000 − 5,000) / 10 D = 45,000 / 10 = $4,500 per year
A company buys office furniture for $30,000 with zero salvage value and a useful life of 6 years. What's the annual depreciation, and what's the book value after 2 years?
D = (30,000 − 0) / 6 = $5,000 per year Book value after 2 years = 30,000 − (2 × 5,000) = $20,000
Flashcards
Quick quiz
Q1.A machine costs $40,000, has a $4,000 salvage value, and a 6-year useful life. What is its annual straight-line depreciation?
Q2.Which of these best describes depreciation?
Q3.What happens to an asset's book value each year under straight-line depreciation?
Q4.An asset with no salvage value costs $12,000 and has a 4-year life. What is the book value after 3 years?
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Common mistakes
Confusing depreciation with a decline in market price. — Correct: Depreciation is an accounting allocation of cost, not a market valuation.
Forgetting to subtract salvage value before dividing. — Correct: Always subtract salvage value first: D=(C−S)/n.
Treating depreciation as a cash expense in cash-flow analysis. — Correct: Depreciation is non-cash — add it back when calculating operating cash flow.
Assuming all assets use straight-line depreciation. — Correct: Other methods exist too, like declining balance and units of production.
FAQ
What is depreciation in accounting?
Depreciation is the process of allocating a tangible asset's cost over its useful life, reflecting wear and use rather than a cash payment.
What is the depreciation formula?
The straight-line formula is D = (Cost − Salvage Value) / Useful Life, giving equal expense each year.
How do you calculate depreciation?
Subtract the salvage value from the asset's cost, then divide by its useful life in years.
What are examples of depreciation?
Vehicles, machinery, computers, and buildings losing value as they're used over multiple years are classic depreciation examples.