Glossary
Depreciation
Spreading the cost of a tangible asset such as equipment over its useful life as a yearly non-cash expense.
Depreciation is the accounting process of spreading the cost of a long-lived physical asset, such as a truck, a server farm or a factory, across the years it is expected to be useful. Instead of recording a $5 million machine as a $5 million expense in the year it is bought, a company expenses a slice each year. The idea is to match the cost of the asset with the revenue it helps produce.
How it is calculated
The simplest and most common method is straight-line:
Accelerated methods such as declining balance put more of the expense in the early years. Land is never depreciated, and the equivalent process for intangible assets such as patents is called Amortization.
Where it appears in the statements
- Income statement: depreciation reduces Operating income and therefore Net income, though it is often buried within cost of sales and operating expenses.
- Cash flow statement: because no cash leaves the company when depreciation is recorded, it is added back in Operating cash flow. The cash went out earlier, as Capital expenditure (capex).
- Balance sheet: accumulated depreciation lowers the carrying value of property and equipment.
Why investors care
Depreciation is "non-cash" only in the sense that the cash was already spent. A business that must keep replacing its equipment has a real ongoing cost, which is why EBITDA, which adds depreciation back, can flatter capital-heavy companies. Comparing depreciation with capital spending shows whether a firm is investing enough to maintain its asset base. Tax depreciation rules often differ from the ones used in published accounts.