Finance & Accounting
Definition
Depreciation is the accounting process of allocating the cost of a tangible asset (equipment, vehicles, buildings) over its useful life. Rather than expensing the full cost in the year of purchase, depreciation spreads the expense across multiple years, matching costs with the revenue the asset helps generate.
The most common depreciation method is straight-line depreciation: divide the asset's cost (minus salvage value) by its useful life. A $50,000 machine with a 10-year life and no salvage value generates $5,000 of annual depreciation. Accelerated methods like MACRS (the IRS-mandated method for US tax purposes) and double-declining balance front-load more depreciation in early years. Bonus depreciation and Section 179 allow businesses to immediately expense some or all of qualifying asset purchases for tax purposes — a significant tax planning tool. Depreciation reduces taxable income without reducing cash flow (it's a non-cash charge), which is why it's added back in EBITDA and cash flow analysis. Accumulated depreciation on the balance sheet represents the total depreciation taken against an asset since purchase.
Depreciation has real tax implications — choosing the right method and timing for major asset purchases can accelerate tax deductions significantly. Bonus depreciation and Section 179 elections are powerful tools a tax advisor can help you optimize. An accountant can ensure your depreciation schedules are accurate and IRS-compliant.