Depreciation expense is the portion of a long-term asset’s cost that a business records as an expense during a given accounting period. Instead of recording the entire cost of a piece of equipment, a vehicle, or a building in the year it’s purchased, the business spreads that cost across the years the asset will be used. If you buy a $50,000 delivery truck expected to last ten years, you don’t show a $50,000 hit to your profits in year one. You show $5,000 per year for ten years (or something close to that, depending on the method you choose).
Why Businesses Spread the Cost Over Time
Depreciation exists because of a core accounting rule called the matching principle. Under generally accepted accounting principles (GAAP), expenses should be recorded in the same period as the revenue they help generate. A delivery truck doesn’t produce value only in the year you buy it. It helps you earn revenue for years, so the cost should be spread across those years too.
This is part of accrual accounting, where you recognize costs when they’re incurred economically, not just when cash changes hands. Depreciation is a “non-cash” expense, meaning no money leaves your bank account when you record it each period. The cash went out the door when you bought the asset. Depreciation simply allocates that past cash outflow to the periods that benefit from it.
Which Assets Can Be Depreciated
Not everything a business buys qualifies. The IRS says depreciable property includes machinery, equipment, buildings, vehicles, and furniture, but only if the asset meets all of these conditions:
- You own it. Leased property generally isn’t yours to depreciate (the lessor depreciates it instead).
- It’s used in a business or income-producing activity. A personal car you never use for work doesn’t count.
- It has a determinable useful life. You need a reasonable estimate of how long it will last.
- It’s expected to last more than one year. Office supplies and other short-lived items are expensed immediately.
Land is never depreciable. Because land doesn’t wear out or become obsolete, it has no determinable useful life. However, buildings sitting on that land, along with certain land improvements like paving or fencing, can be depreciated.
How to Calculate Depreciation
Three variables drive most depreciation calculations: the asset’s purchase price, its salvage value (what you expect it to be worth when you’re done with it), and its estimated useful life. How you combine those variables depends on the method you choose.
Straight-Line Method
This is the most common approach and the simplest. The formula is:
(Purchase Price − Salvage Value) ÷ Estimated Useful Life = Annual Depreciation Expense
Say you buy a $40,000 machine with a $4,000 salvage value and a 9-year useful life. Your annual depreciation expense is ($40,000 − $4,000) ÷ 9 = $4,000 per year, every year, for nine years. Accountants favor this method because it’s easy to apply and produces consistent, predictable expense amounts each period.
Double-Declining Balance Method
This is an accelerated method, meaning it front-loads more expense into the early years of an asset’s life. You take double the straight-line rate and apply it to the asset’s remaining book value each year. For an asset with a 10-year life, the straight-line rate would be 10% per year, so the double-declining rate is 20%. In year one, you’d depreciate 20% of the full cost. In year two, you’d depreciate 20% of whatever book value remains, and so on. The annual expense shrinks over time. Businesses use this method when an asset loses most of its productive value early, like computers or other technology.
Units of Production Method
Instead of spreading costs evenly over time, this method ties depreciation to actual usage. You estimate how many total units the asset will produce (or miles it will drive, or hours it will run), then expense a per-unit cost based on real output each period. A factory machine expected to produce 500,000 widgets over its life would have its cost divided by 500,000, and each year’s depreciation depends on how many widgets it actually made. This is useful for assets whose wear depends more on use than on the calendar.
How Depreciation Shows Up on Financial Statements
Depreciation touches two major financial statements, and understanding where it lands helps you read a company’s books (or your own).
On the income statement, depreciation appears as an indirect operating expense. It reduces gross profit alongside other overhead costs like administrative salaries and marketing. Because it lowers reported profit, it also lowers taxable income, which is one reason depreciation matters so much at tax time.
On the balance sheet, a related account called accumulated depreciation tracks the total depreciation recorded against an asset since it was purchased. Each period, the depreciation expense entry increases accumulated depreciation, which is subtracted from the asset’s original cost. The result is the asset’s “book value” or “net book value.” If you bought that $40,000 machine and have recorded $12,000 in total depreciation so far, the balance sheet shows the machine at a net book value of $28,000.
The journal entry itself is straightforward: you debit (increase) depreciation expense on the income statement and credit (increase) accumulated depreciation on the balance sheet. No cash account is involved, which is why depreciation is added back to net income on the cash flow statement when calculating operating cash flow.
Depreciation for Tax Purposes
The depreciation you calculate for your financial statements (often called “book depreciation”) doesn’t have to match what you claim on your tax return. The IRS has its own system, called the Modified Accelerated Cost Recovery System (MACRS), which assigns specific recovery periods to different types of property. Office furniture might get a 7-year recovery period, while a commercial building gets 39 years.
Beyond the standard MACRS schedule, the tax code offers ways to accelerate deductions even further. Section 179 lets qualifying businesses deduct the full purchase price of eligible equipment and software in the year it’s placed in service, up to an annual dollar limit. This turns what would normally be years of gradual deductions into a single, immediate write-off.
Bonus depreciation provides another route. Under legislation signed into law in 2025, qualifying property acquired after January 19, 2025, is eligible for a permanent 100% additional first-year depreciation deduction. That means a business can deduct the entire cost of qualifying assets in the first year. Taxpayers also have the option to elect a 40% first-year deduction instead of the full 100% for property placed in service during the first tax year ending after January 19, 2025 (60% for certain property with longer production periods or certain aircraft).
These accelerated tax deductions don’t change the total amount you’ll ever deduct. They simply shift the timing, giving you a bigger tax benefit now and a smaller one later. For cash flow planning, that front-loaded tax savings can be significant.
A Practical Example Start to Finish
Suppose you run a small business and buy a commercial oven for $30,000. You expect it to last 10 years and be worth $2,000 at the end. Using straight-line depreciation, your annual expense is ($30,000 − $2,000) ÷ 10 = $2,800.
Each year, your income statement shows a $2,800 depreciation expense, reducing your taxable profit by that amount. On your balance sheet, accumulated depreciation grows by $2,800 annually. After three years, the oven’s book value is $30,000 − $8,400 = $21,600. After all ten years, the book value equals the $2,000 salvage value, and depreciation on that asset stops. You never depreciate an asset below its estimated salvage value.
On your tax return, you might claim depreciation on a different schedule, potentially deducting a much larger amount in year one through Section 179 or bonus depreciation. The book and tax numbers reconcile over the asset’s life, but the annual figures can look quite different.