Depreciation

Depreciation spreads the cost of physical assets (buildings, equipment, vehicles) across the years they are used.

Common methods

Straight-line

Equal expense each year. A $100,000 machine with 10-year life = $10,000/year.

Declining balance

Higher expense in early years, declining over time. Reflects that assets lose more value when new.

Units of production

Based on actual usage. A machine expected to produce 1 million units depreciates per unit produced.

Why it matters for investors

• Depreciation is a non-cash expense that reduces reported earnings
• Cash flow statements add depreciation back because no cash actually left the company
• Capital-intensive businesses have higher depreciation, which can mask true profitability
• Compare depreciation to capital expenditures—if capex consistently exceeds depreciation, the company is investing for growth

Tax implications

Accelerated depreciation methods reduce taxable income in earlier years, deferring tax payments. This is a real economic benefit even though it's an accounting concept.