Definition
Depreciation spreads the cost of physical assets (buildings, equipment, machinery) over their expected useful lives. Common methods include straight-line (equal amounts each year), declining balance (accelerated), and units of production. Depreciation is a non-cash expense that reduces taxable income, creating a tax shield. It appears on both the income statement (expense) and balance sheet (accumulated depreciation).
functions Formula
Straight-Line Depreciation = (Cost − Salvage Value) / Useful Life
lightbulb Example
A machine costs $100K with $10K salvage value and 10-year useful life. Annual straight-line depreciation = ($100K-$10K)/10 = $9K. This $9K reduces taxable income each year despite no cash outflow.
verified_user Key Points
- Non-cash expense reducing taxable income
- Straight-line, declining balance, and units of production methods
- Creates tax shield (tax rate × depreciation)
- Added back in cash flow from operations