Glossary Finance

Depreciation

Depreciation is the loss in value of an asset over time through wear, age or obsolescence, or the accounting method of spreading its cost across its useful life.

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In more detail

With straight-line depreciation, the cost minus the expected salvage value is spread evenly over the useful life. Declining-balance methods apply a fixed percentage to the remaining book value each year, so they take more in the early years; double-declining balance uses twice the straight-line rate. Book value never drops below the salvage value. Tax rules often prescribe their own schedules, which can differ from the ones used in a company's accounts.

Why it matters

For a business, depreciation turns a large purchase into yearly expenses that reduce reported profit and often taxable income. For a car owner, real-world depreciation is usually the largest cost of ownership in the first years, which matters when choosing a loan term or a lease.

Example

A $30,000 vehicle expected to be worth $6,000 after 5 years. Straight line: (30,000 − 6,000) / 5 = $4,800 a year. Double-declining balance (40% a year):

Year Depreciation Book value
1 $12,000 $18,000
2 $7,200 $10,800
3 $4,320 $6,480
4 $480 $6,000
5 $0 $6,000

Year 4 is capped so book value stops at the salvage value.

Common confusion

Amortization is the same idea for intangible assets, and also the word for repaying a loan in instalments.

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