Depreciation allocates a tangible asset's depreciable amount across the periods in which the business expects to use it.
Depreciation is the systematic allocation of a tangible long-lived asset’s depreciable amount over its useful life. It is an accounting expense, not a current-period cash payment or a live estimate of the asset’s market price.
| Term | Meaning |
|---|---|
| Depreciable asset | A tangible asset whose recognized amount is allocated over periods of use |
| Depreciable base or basis | The amount subject to depreciation; terminology and calculation can differ between financial reporting and tax |
| Useful life | The period or production capacity over which the entity expects to use the asset |
| Residual or salvage value | Estimated amount expected from disposal at the end of useful life, after relevant disposal costs |
| Depreciation method | Pattern used to allocate the depreciable amount |
| Depreciation rate | Periodic percentage used by a particular method |
| Depreciation schedule or system | Record of assets, methods, dates, rates, and periodic expense |
| Accumulated depreciation | Contra-asset balance representing depreciation recorded to date |
| Net book value | Common shorthand for cost less accumulated depreciation and applicable write-downs |
“Provision for depreciation” and “depreciation reserve” are older or jurisdiction-specific labels for periodic depreciation expense or accumulated depreciation. Accumulated depreciation is normally a contra-asset balance, not an equity reserve, replacement fund, or segregated cash account. “Wear and tear” may help explain why an asset becomes less useful, but depreciation is a cost-allocation process and is not limited to visible physical deterioration.
Suppose equipment costs $120,000, has an estimated residual value of $20,000, and is expected to be used for five years.
The entity records $20,000 of annual depreciation under a simple straight-line schedule. After two full years, accumulated depreciation is $40,000 and the simplified carrying amount is $80,000, before any impairment or other adjustment.
A basic year-end entry is a debit to depreciation expense and a credit to accumulated depreciation. Accumulated depreciation is a contra-asset account; it is not cash held for replacement.
| Method | Expense pattern | When it may be informative |
|---|---|---|
| Straight-line depreciation | Equal periodic amount | Benefits are consumed relatively evenly |
| Diminishing-balance method | More expense in earlier periods | Benefits or productivity decline over time |
| Units of production | Expense follows units, hours, or another usage measure | Consumption depends more on activity than time |
| Accelerated depreciation | More cost recovered earlier | A reporting method or tax rule creates front-loaded deductions |
Linear depreciation and equal-instalment depreciation are common names for straight-line allocation. Reducing-balance depreciation is another name for a diminishing- or declining-balance method.
Depreciation generally begins when an asset is available for use: it is in the location and condition necessary for its intended operation. That date can differ from the order, payment, delivery, installation, or first-production date.
Examples:
Under IAS 16, depreciation ceases at the earlier of classification as held for sale under IFRS 5 or derecognition. It does not stop merely because the asset is idle, unless it is fully depreciated or the selected usage-based method produces no charge because there is no production.
Significant parts of one asset can have different useful lives or consumption patterns. An aircraft body and engines, a building structure and elevators, or a furnace and its replaceable lining may require separate component schedules. Component accounting prevents one blended life from obscuring materially different replacement cycles.
Useful life is the period or production capacity over which the entity expects to use the asset. It can be shorter than physical life because of maintenance policy, technology, demand, legal limits, expected replacement, or obsolescence. Residual value also depends on the expected disposal condition and market.
Suppose an asset has a carrying amount of $72,000 after two years. New operating evidence indicates a $12,000 residual value and three remaining years of useful life. If straight-line allocation remains appropriate, revised annual depreciation is:
Under the usual change-in-estimate treatment, the revised amount is applied prospectively. Prior expense is not automatically restated. A correction is different when the old schedule resulted from a mathematical mistake, ignored available information, or misapplied an accounting policy.
Depreciation connects all three core statements:
The cash outflow usually occurred when the asset was purchased. The acquisition may appear as an investing cash outflow, while depreciation is recorded later.
Depreciation does not continuously reprice an asset. A machine with a carrying amount of $80,000 might sell for more or less than that amount. Market depreciation, unrealized depreciation, and appreciation describe changes in economic or market value; they are not substitutes for an accounting depreciation schedule.
If facts indicate that an asset may not recover its carrying amount, impairment analysis may be required under the applicable framework.
Financial reporting aims to reflect consumption of an asset’s service potential under the applicable accounting framework. Tax systems determine deductible cost recovery under jurisdiction-specific law. The two schedules may differ in basis, recovery period, convention, method, and timing.
For U.S. federal tax, the IRS explains applicable property classes, methods, conventions, and records in Publication 946. Tax treatment depends on current law and the taxpayer’s facts; this page is not tax advice.
For a company or asset group, review:
The ratio of accumulated depreciation to gross depreciable assets can offer a rough view of asset age, but acquisitions, disposals, inflation, currency translation, revaluation, and asset mix limit the inference. Depreciation below capital expenditures can indicate growth, replacement, price inflation, or long asset lives; it does not prove underinvestment or overinvestment by itself.
This article is educational. Accounting and tax conclusions should be checked against the applicable standards, law, entity policy, and professional advice.