Why do we charge depreciation?

We charge depreciation because most of the long-lived assets used in a business have 1) a significant cost, and 2) they will be useful only for a limited number of years. The matching principle (a basic underlying accounting principle) requires that the actual cost of these assets be allocated to the accounting periods in which the company will benefit from their use.

The depreciation reported on a U.S. corporation's external financial statements is computed by spreading an asset's cost (less any salvage value) over the asset's service life or useful life. For example, equipment with a cost of $500,000 and no salvage value at the end of an assumed useful life of 10 years will likely result in matching $50,000 to each full accounting year. (The U.S. income tax rules allow accelerating the depreciation amounts, but the total cannot exceed the asset's cost.)

Examples of the assets that must be depreciated include machinery, equipment, fixtures, furnishings, buildings, vehicles, etc. These assets are often referred to as fixed assets or plant assets, and the amounts spent are part of a corporation's capital expenditures. (Note that land is not depreciated because it is assumed to last indefinitely.)

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