Depreciation is an accounting term that refers to the decrease in the value of an asset over time due to natural wear and tear, obsolescence, or other factors. It is a process of allocating the cost of a tangible or physical asset over its useful life. Depreciation is a non-cash expense, meaning that it does not result in any cash outflow.

Businesses depreciate long-term assets for both accounting and tax purposes. The decrease in value of the asset affects the balance sheet of a business or entity, and the method of depreciating the asset, accounting-wise, affects the net income, and thus the income statement that they report. There are several methods that accountants commonly use to depreciate capital assets and other revenue-generating assets, including:

• Straight-line method: This is the most basic way to record depreciation. It reports an equal depreciation expense each year throughout the entire useful life of the asset until the entire asset is depreciated to its salvage value.

• Declining balance method: This is an accelerated depreciation method that depreciates the machine at its straight-line depreciation percentage times its remaining depreciable amount each year. Because an assets carrying value is higher in earlier years, the same percentage causes a larger depreciation expense amount in earlier years, declining each year.

• Double-declining balance method: This is a slightly more complicated way to depreciate an asset. It lets you write off more of an asset’s value in the days immediately after you buy it and less later on. It is often used for equipment when the units of production method is not used.

• Units of production method: This method is used when the assets value is more closely related to its usage than to the passage of time. The depreciation expense is based on the number of units produced or the number of hours the asset is in use.

Properly recognizing depreciation in financial statements can help businesses plan for and manage their cash requirements.