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What Is Depreciation?
Depreciation is the systematic allocation of an asset's cost over its useful life. Businesses use it to match the expense of an asset with the revenue it generates, following the matching principle in accounting. It also reduces taxable income — the IRS and most tax authorities allow businesses to deduct depreciation as an expense.
Depreciation Methods
| Method | How it works | Best for |
|---|---|---|
| Straight-Line | Equal amount each year: (Cost − Salvage) / Useful Life | Buildings, furniture, most assets |
| Double Declining Balance | 2× straight-line rate applied to book value | Assets that lose value quickly (vehicles, tech) |
| Sum-of-Years-Digits | Accelerated; higher depreciation in early years | Assets with high early productivity |
| Units of Production | Based on actual usage, not time | Manufacturing equipment, vehicles |
| MACRS | IRS-mandated accelerated method for US tax purposes | US business tax filings |
Straight-Line Example
Text
Asset: Company vehicle
Cost: $30,000
Salvage value: $5,000
Useful life: 5 years
Annual depreciation = ($30,000 - $5,000) / 5 = $5,000/year
Year 1: Book value $25,000 (depreciation $5,000)
Year 2: Book value $20,000 (depreciation $5,000)
Year 3: Book value $15,000 (depreciation $5,000)
Year 4: Book value $10,000 (depreciation $5,000)
Year 5: Book value $5,000 (depreciation $5,000) = salvage valueDouble Declining Balance Example
Text
Same asset: $30,000 cost, $5,000 salvage, 5-year life
DDB rate = 2 / 5 = 40%
Year 1: $30,000 × 40% = $12,000 → Book value $18,000
Year 2: $18,000 × 40% = $7,200 → Book value $10,800
Year 3: $10,800 × 40% = $4,320 → Book value $6,480
Year 4: Switch to straight-line: ($6,480 - $5,000) / 2 = $740
Year 5: $740 → Book value $5,000 = salvage value