Debt Dictionary

Depreciation

Investment Dictionary -> Depreciation

Depreciation refers to non-monetary expense which is recorded to specify the cost of a tangible asset over the length of its useful life. In brief, the term is used for cost allocation over the period during which the asset generates revenue. Depreciation also stands for reduction in the asset’s value. The process increases the free cash flows and decreases the reported earnings of the company. Depreciation stops at a certain point of time in which the asset loses its entire value. Typically, depreciation is due to the use of the asset, attrition, depletion, time passage, obsolescence, or other relevant factors.

The term usually covers assets with brief and fixed useful life. Depreciation is usually used for assets that will last for a period that is longer than one year. This category comprises of buildings, equipment, machinery, vehicles, parking lots, office equipment, furniture, and outdoor lighting, among others. Such assets are grouped under different terms such as ‘constructed assets’, ‘depreciable assets’, ‘plant assets’, and ‘property, plant, and equipment’. It is assumed that land cannot be depreciated because this asset lasts indefinitely. Moreover, the term does not cover assets with indefinite useful life. Depreciation has no bearing over the market value of the asset. It aims to specify the portion of an asset which is depleted and cannot be recovered through any form of disposal.

One needs to know the initial cost of an asset in order to calculate its annual depreciation. There are two principal ways to calculate depreciation. Firstly, deprecation expenses are recorded on the income statement of the company. The balance sheet includes the value of the asset. This method is referred to as the cost principle. Secondly, the cost of the asset may be allocated to depreciation expenses covering the useful life of the asset. This approach is known as the matching principal.


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