A Brief Introduction To Depreciation

Depreciation is a term we hear about frequently but don’t understand. It’s an essential component of accounting, however. Depreciation is an expense recorded at the same time and in the same period as other accounts. When you own long-term operating assets not held for sale in the course of business, they are called fixed assets. Fixed assets include buildings, machinery, office equipment, vehicles, computers, and other equipment. It can also include items such as shelves and cabinets. Depreciation refers to spreading out the cost of a fixed asset over the years of its useful life to a business instead of charging the total price to expense in the year you purchased the asset. That way, each year, the asset is used bears a portion of the cost of the equipment. As an example, you typically depreciate cars and trucks over five years. The idea is to charge a fraction of the total cost to depreciation expense every five years, rather than just the first year.

Depreciation applies only to fixed assets that you buy, not rent or lease. Depreciation is an actual expense but not necessarily a cash outlay expense each year. The cash outlay does occur when the fixed asset is acquired. Still, you record the depreciation over the period it is used.

Depreciation is different from other expenses. It is deducted from sales revenue to determine profit. Still, the depreciation expense recorded in a reporting period doesn’t require any actual cash outlay during that period. Depreciation expense is that portion of the total cost of a business’s fixed assets that is allocated to record the cost of using the assets during the period. The higher the total cost of a business’s fixed assets, the higher its depreciation expense.