Depreciation is the decreasing value of a business asset over time. Mainly, businesses show depreciation as an expense, and it happens due to multiple factors, including wear and tear or assets becoming outdated.
Common assets that depreciate with use and time are machinery, equipment, and vehicles. Businesses consider this value and spread the cost over the timeline in which it is estimated to be useful.
How It Works:
- A business purchases an asset such as machinery.
- The cost is spread over its useful life.
- A portion of the asset value is expensed each year.
- The asset value reduces over time in the books.
- Depreciation is recorded in financial statements.
Benefits:
- Helps in accurate financial reporting
- Provides tax advantages
- Reflects true asset value over time
- Aids in budgeting for replacements
Example:
A company buys a machine for Rs 5 lakh, which works for many years. The cost of the machine is accounted for as depreciation over time till it was useful. The investment of Rs 5 lakh is not shown as a complete expense in one year.