Depreciation is the accounting process of allocating the cost of a tangible asset over its useful life. It reflects the decrease in value of the asset as it is used over time, due to factors such as wear and tear, obsolescence, or age.
In financial statements, depreciation helps businesses match the cost of an asset with the revenue it generates, which adheres to the matching principle in accounting. There are several methods to calculate depreciation, with the most common being:
- Straight-Line Depreciation: The asset's cost is evenly spread over its useful life.
- Declining Balance Depreciation: A higher amount of depreciation is recognized in the earlier years of the asset's life.
- Units of Production Depreciation: Depreciation is based on the asset's usage or production levels.
Depreciation is a non-cash expense and is important for both tax purposes and financial reporting, as it affects net income and asset valuation on the balance sheet.