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What Is Depreciation?

Depreciation is an accounting procedure that allocates the acquisition cost of a fixed asset, such as a building or piece of equipment, as an expense over its period of use.

What the procedure represents

Fixed assets such as buildings, machinery, and vehicles are used over multiple years rather than just the year they are acquired. This procedure, called depreciation, splits the acquisition cost across the asset's useful life and records a portion as an expense in each period.

Points to watch when reading it

Because depreciation expense does not involve an actual cash outflow, some investors reference indicators such as EBITDA — net income with depreciation and similar items added back — as a way of looking at cash-based earning power.

This article is provided for general informational purposes only and does not recommend or solicit the purchase or sale of any specific investment method or security. Final investment decisions are your own responsibility.

Frequently Asked Questions

Why is depreciation an expense that doesn't involve a cash outflow?
The cash was already paid out when the fixed asset was acquired; depreciation simply allocates that already-spent cost, on the books, over the period the asset is used. That's why, even though it's an expense on the income statement, it is added back as an adjustment on the cash flow statement.
What methods of depreciation are there?
Common methods include the straight-line method, which expenses an equal amount each period, and the declining-balance method, which applies a fixed rate to the book value at the start of each period. Which method a company adopts affects the profit reported in each period.

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