Why do assets depreciate?

Physical assets wear out or become outdated, so their ability to produce income is used up. Depreciation in accounting records that use as an expense each year.

Is depreciation a cash expense?

No. The cash is paid when the asset is bought. Depreciation expense lowers reported profit later without further cash leaving the business.

What is the difference between depreciation and amortization?

The type of asset. Depreciation in accounting covers tangible assets such as machines and buildings, while amortization covers intangible ones such as patents and licences. The calculations are very similar.

No. Land does not wear out and has no fixed useful life, so it stays on the balance sheet at cost. Buildings on the land are depreciated separately, with their own accumulated depreciation.

What happens when an asset is fully depreciated?

The charges stop. The asset stays on the books at its salvage value, or at zero, with accumulated depreciation equal to its depreciable base, until it is sold or scrapped.

Does depreciation show the market value of an asset?

Not at all. Depreciation expense allocates historical cost under a chosen method, while market value depends on what buyers will pay. The two can drift far apart.

What Does Depreciation Mean and How Is It Used in Accounting?

When a company buys a machine that will last for years, the cost is not charged against profit in a single year. Depreciation in accounting spreads that cost over the asset's useful life, so each year's profit carries its share of the expense.

BearishEdited

October 23, 2026

Written by Albert Robertson

Reviewed by Sue Wright

LSE-educated trader with hands-on experience in stocks and crypto, covering education, strategies, and market terminolog

Reviewed by Sue Wright

October 23, 2026

What Is Depreciation in Accounting

Depreciation is the systematic allocation of the cost of a tangible fixed asset, such as equipment, vehicles or buildings, over the years it is expected to be used. It follows the matching principle: an expense is recorded in the same period as the revenue it helps produce. A delivery van used for eight years earns revenue in each of them, so its cost is spread across all eight.

Which Assets Depreciate

Depreciation applies to physical, long-lived assets that wear out or become outdated: machinery, computers, vehicles, furniture and buildings. Land is not depreciated, because it has no limited useful life. Intangible assets such as patents or software licences are handled through amortization, which applies the same idea to assets without physical form.

Cost, Useful Life and Salvage Value

Every depreciation schedule rests on three inputs. Cost is the purchase price plus delivery and installation. Useful life is the period, or number of units, over which the asset will be used. Salvage value is what the asset is expected to fetch at the end of that life.

Cost minus salvage value gives the depreciable base, the total to be expensed. Useful life and salvage value are management estimates and can be revised.

Main Depreciation Methods

Four methods are in common use:

Straight line depreciation: (cost - salvage value) ÷ useful life, the same charge every year.
Declining balance method: a fixed rate applied to the remaining book value; the double version uses twice the straight line rate, so charges start high.
Sum-of-years' digits: the depreciable base multiplied by a falling fraction, remaining life ÷ sum of the years' digits.
Units of production: (cost - salvage value) ÷ total expected units × units produced in the year.

The straight line approach is the most widely used because it is simple to apply.

Worked Example: One Asset, Three Methods

A company buys a machine for $10,000 with a salvage value of $1,000 and a useful life of five years, so the depreciable base is $9,000.

Method	Year 1 calculation	Year 1 depreciation expense
Straight line	9,000 ÷ 5	$1,800
Double declining balance	10,000 × 40%	$4,000
Sum-of-years' digits	9,000 × 5 ÷ 15	$3,000

Over five years each method expenses the same $9,000; only the timing differs. That timing changes first-year profit, and with it measures such as the P/E ratio, so analysts check which method a company uses.

How Depreciation Appears in Financial Statements

Each year's charge is recorded as depreciation expense on the income statement, reducing operating profit. On the balance sheet the asset stays at cost, and the running total of charges is shown as accumulated depreciation. Cost minus accumulated depreciation is book value: after year one under straight line, $10,000 - $1,800 = $8,200.

Depreciation is a non-cash expense, since the cash left when the asset was bought, so the cash flow statement adds it back to net income. Anyone following listed companies, a core part of how the stock market works, meets this gap between profit and cash flow.

Book Depreciation vs Tax Depreciation

Companies often keep two schedules. Book depreciation follows accounting standards; tax depreciation follows tax law, which may allow faster write-offs, as the MACRS system and bonus depreciation do in the US. The difference shifts taxable income between years and is recorded as deferred tax. Reported earnings, the figures any stock earnings analysis starts from, use book depreciation. Neither schedule estimates market value: a fully depreciated machine may still be worth a lot.

Conclusion

Depreciation in accounting spreads the cost of a long-lived tangible asset over its useful life, so profit carries the expense in the years the asset is used. When reading accounts, check which method and useful life a company applies, remember that depreciation expense uses no cash, treat book value with care because it is not market value, and keep tax depreciation separate from reported profit.

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Disclaimer: This article is for informational purposes only and does not constitute financial advice. Trading involves risk, and losses can exceed initial deposits.

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