Depreciation

Before you rely on it

What to check

Do not read book depreciation as a market value estimate.

The common error

Where people go wrong with depreciation

Pricing a used asset for sale off the depreciation schedule. Buyers price on condition and demand, and the accounts have no opinion about either.

Worked through

Depreciation in plain numbers

Two meanings, one word. For a business, an asset costing $30,000 with a $6,000 salvage value and a five-year life loses $24,000 over five years. Straight-line depreciation is $4,800 a year. In year one the book value falls from $30,000 to $25,200. For a car owner, depreciation is the drop in market value, and a $30,000 car that loses 20% in the first year is worth $24,000, then perhaps 15% more the next year, near $20,400. The first is a scheduled accounting entry. The second is what buyers actually pay. The two figures are rarely the same.

Easily confused

Depreciation and its neighbours

Depreciation is not amortization or wear and tear in the everyday sense. Amortization spreads the cost of intangible assets, or the repayment of a loan. Depletion applies to natural resources. Accounting depreciation follows rules and methods, such as straight-line or declining balance, while market depreciation follows prices. Tax depreciation can be faster than book depreciation, so the same asset can have two different carrying values. In casual talk, people say an asset depreciates whenever it loses value, which mixes all of these ideas together.

In real decisions

Where depreciation turns up

Businesses use it to spread costs and match them to the periods that benefit. Tax planning uses depreciation deductions to reduce taxable income. Rental property owners depreciate buildings. Car buyers consider it when deciding whether to buy new or used, since the steepest losses come early. Insurers and lenders use expected depreciation to set values; comparing total cost of ownership across vehicles usually starts with how fast each loses value.

Know the edges

Where depreciation stops being reliable

Depreciation schedules use estimates of useful life and salvage value that may prove wrong. Rules differ by country, asset and year, and they change. Market depreciation depends on condition, mileage, demand and timing, and no formula captures it exactly. Calculators show typical patterns. For tax treatment of a specific asset, confirm the current rules with a qualified professional.

Quick answers

What people ask about depreciation

Is depreciation a cash expense? No. It is an accounting allocation of a purchase already paid for. It lowers reported profit and, through tax deductions, can reduce cash taxes.

Which method is most common? Straight-line, which spreads cost evenly. Declining balance and units-of-production are used when wear is faster early or tied to output.

Do cars lose value the same way every year? No. The biggest drop is often in the first years, then the rate slows. Mileage, condition and demand change the pattern.

What is salvage value? The estimated value of an asset at the end of its useful life. It reduces the amount to be depreciated.