Why do we charge depreciation?

Definition of Depreciation

Accountants charge (to expense) depreciation on assets such as buildings, equipment, vehicles, etc. because the assets:

  • Have a significant cost
  • Will be useful for more than a year
  • Will not be useful indefinitely

Since the asset land is assumed to be useful indefinitely, there is no depreciation charge associated with the cost of land.

Depreciation attempts to match an asset's cost (minus any expected salvage value) with the revenues that the asset will be generating over an estimated number of accounting periods.

Example of Depreciation Charges

Assume that a corporation purchased equipment to be used in its business at a cost of $500,000. It is expected that the equipment will have no salvage value at the end of an estimated useful life of 10 years. For its financial statements the corporation will usually charge the same amount each year. In our example, this means $50,000 ($500,000/10 yrs) of annual depreciation expense for 10 years. (U.S. income tax rules allow accelerating the yearly depreciation amounts, but the total amount of depreciation cannot exceed the asset's cost.)

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