Depreciation

Depreciation is the accounting process of allocating the cost of a tangible Asset over its useful life. It reflects the reduction in value of an Asset due to factors such as wear and tear, obsolescence, or age. Businesses use depreciation to match the cost of an Asset with the Revenue it generates over time, thereby adhering to the matching principle in accounting.

For example, if a company purchases machinery for $100,000 with an estimated useful life of 10 years, it may depreciate the Asset by $10,000 each year using straight-line depreciation. After five years, the machinery would have a Book Value of $50,000.

In another case, a vehicle bought for $20,000 may depreciate at a rate of 15% annually. In the first year, the vehicle would depreciate by $3,000, leaving a Book Value of $17,000. In the second year, the depreciation would be based on the new Book Value, resulting in a lower depreciation expense.