What Is Depreciation? Methods and Examples

By Markets & Investing DeskUpdated Nov 10, 2026

Definition

Depreciation is the accounting method that spreads the cost of a tangible, long-lived asset, such as a truck, machine or building, over the years a business expects to use it.

Key takeaways

Straight-line depreciation divides cost minus salvage value by useful life and charges the same amount each year.
All methods expense the same total, but accelerated methods such as DDB shift more expense into early years.
Land is never depreciated because it is treated as having an unlimited useful life.
A company can use straight-line for its financial statements and an accelerated method for its tax return.

Depreciation is the accounting method that spreads the cost of a tangible, long-lived asset over the years a business expects to use it. A company that buys a delivery truck, a machine or a building does not expense the full price in the year of purchase. It records a portion of that cost as depreciation expense in each period of the asset’s useful life, matched against the revenue the asset helps produce.

Depreciation is an allocation of cost, not a measurement of what the asset is worth today. That difference explains most of the confusion around the term.

How depreciation works

Every depreciation calculation draws on the same handful of inputs.

Tangible asset: Depreciation applies to physical assets expected to last more than one year, often called fixed assets, capital assets or property, plant and equipment. Land is excluded because it is treated as having an unlimited useful life. The building on the land is depreciated.
Cost: The purchase price plus the expenses needed to get the asset ready for use, such as shipping, installation and setup.
Useful life: How long the business expects the asset to be productive for that business, not how long it could physically last. Accounting standards and tax rules often set or constrain this period.
Salvage value (residual value): What the company expects to receive when it sells, scraps or trades in the asset at the end of its useful life. It can be zero. A longer useful life generally means a lower expected residual value.
Depreciable base: Cost minus salvage value, the total amount expensed over the asset’s life.
Depreciation rate: The share of the depreciable base charged per year. Under straight-line, the rate is 1 ÷ useful life, so a five-year asset depreciates at 20% a year.
Accumulated depreciation: The running total of depreciation recorded since the asset was placed in service.
Carrying value (book value): Cost minus accumulated depreciation, the figure shown for the asset on the balance sheet.

Capitalize or expense: the threshold decision

Tracking depreciation on every stapler would cost more than it adds in accuracy, so businesses set a capitalization threshold. Purchases above it are recorded as assets and depreciated, and purchases below it are expensed immediately. A small business might set the line at $500, while a larger company might use $5,000 or $10,000. The threshold is internal policy and should be applied consistently.

Depreciation methods with a worked example

The method changes the timing of the expense, not the total. Every method below expenses the same $45,000 by the end of the asset’s life.

Hypothetical example: A company buys a computer server for $50,000. It expects to use it for five years and to sell it for $5,000 at the end. The depreciable base is $50,000 − $5,000 = $45,000.

Straight-line method

Straight-line is the simplest and most widely used method. It charges the same amount every year.

Formula: (Cost − Salvage value) ÷ Useful life

Annual depreciation: $45,000 ÷ 5 = $9,000
Depreciation rate: 1 ÷ 5 = 20% per year
Carrying value at the end of year 5: $50,000 − $45,000 = $5,000, which equals the salvage value

Declining balance method

Declining balance is an accelerated method. It applies a fixed percentage to the asset’s remaining carrying value rather than to the original base. At the straight-line rate of 20%:

Year 1: $50,000 × 20% = $10,000
Year 2: $40,000 × 20% = $8,000
Year 3: $32,000 × 20% = $6,400

The charge shrinks because the balance it applies to shrinks. At a 1x rate, the balance after five years would still be well above the $5,000 salvage value, so a declining balance schedule can switch to straight-line once straight-line produces the larger charge.

Double-declining balance method

Double-declining balance (DDB) doubles the straight-line rate, here to 40%, and applies it to the remaining carrying value. Salvage value is not subtracted before applying the rate. It acts as a floor instead: the asset is never depreciated below it.

Year 1: $50,000 × 40% = $20,000 (carrying value $30,000)
Year 2: $30,000 × 40% = $12,000 (carrying value $18,000)
Year 3: $18,000 × 40% = $7,200 (carrying value $10,800)
Year 4: $10,800 × 40% = $4,320 (carrying value $6,480)
Year 5: limited to $1,480, bringing the carrying value down to the $5,000 salvage value

Sum-of-the-years’ digits (SYD)

SYD also front-loads the expense, but it works from fractions of the depreciable base. For a five-year life, add the year digits: 1 + 2 + 3 + 4 + 5 = 15. Each year’s fraction uses the remaining years of life as the numerator, starting with the largest.

Year 1: $45,000 × 5/15 = $15,000
Year 2: $45,000 × 4/15 = $12,000
Year 3: $45,000 × 3/15 = $9,000
Year 4: $45,000 × 2/15 = $6,000
Year 5: $45,000 × 1/15 = $3,000

Units of production

Units of production ties depreciation to use rather than time. It fits assets that wear out with activity, such as machines measured in hours or vehicles measured in miles. Suppose the server is expected to handle 1,000,000 computations over its life:

Rate per unit: $45,000 ÷ 1,000,000 = $0.045 per computation
Year 1 at 300,000 computations: 300,000 × $0.045 = $13,500

Comparing the schedules

Year	Straight-line	Double-declining	SYD
1	$9,000	$20,000	$15,000
2	$9,000	$12,000	$12,000
3	$9,000	$7,200	$9,000
4	$9,000	$4,320	$6,000
5	$9,000	$1,480	$3,000
Total	$45,000	$45,000	$45,000

Under DDB, first-year profit before tax is $11,000 lower than under straight-line, even though the server, the cash spent and the total expense are identical. Accelerated methods suit assets that lose usefulness quickly, such as technology that becomes obsolete. Straight-line suits assets that provide roughly even service each year.

How depreciation affects the financial statements

The cash leaves the business when the asset is bought. Depreciation then moves the cost from the balance sheet to the income statement over time.

Income statement: Depreciation expense reduces operating income and net income each period. For manufacturing equipment, it is usually allocated into factory overhead, becoming part of inventory cost and eventually cost of goods sold rather than a separate line.
Balance sheet: The asset stays at its original cost, offset by accumulated depreciation in a contra-asset account, so the net figure is the carrying value. Each period’s entry debits depreciation expense and credits accumulated depreciation.
Cash flow statement: Depreciation reduces net income without using cash, so it is added back when operating cash flow is calculated using the indirect method. The purchase itself appears as a capital expenditure under investing activities.

Because depreciation is a non-cash charge shaped by estimates, analysts sometimes look past it. EBITDA adds depreciation and amortization back to earnings, while free cash flow replaces the accounting charge with actual capital spending.

In the United States, GAAP standards issued by the Financial Accounting Standards Board (FASB) require costs to be matched with the revenue they help generate, so a machine used for five years has its cost spread over those five years.

Depreciation for tax purposes

Depreciation is a tax-deductible expense, so it lowers taxable income. The IRS sets its own rules, separate from financial reporting. To be depreciable for tax purposes, property generally must:

Be owned by the taxpayer (not leased)
Be used in a business or income-producing activity
Have a determinable useful life
Be expected to last more than one year
Not fall into an excluded category, such as intangible property (which is generally amortized instead)

Most business property in the U.S. is depreciated for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). The IRS publishes recovery periods for different classes of property in Publication 946. Section 179 lets businesses deduct the full cost of qualifying equipment in the year it is placed in service, subject to limits. Bonus depreciation provisions can also accelerate deductions.

A company can use straight-line for its financial statements and an accelerated method for its tax return. The gap between book depreciation and tax depreciation is one source of deferred tax balances on the balance sheet.

Carrying value vs. market value

Carrying value records how much of an asset’s cost has not yet been expensed, not what the asset would fetch if sold. A data center or a fleet of trucks may have a book value that declines on a fixed schedule while its market value rises when demand is strong, or falls faster when newer technology makes it obsolete. When an asset’s value drops sharply and permanently below its carrying amount, accounting rules call for an impairment write-down.

Limitations of depreciation

It rests on estimates. Useful life and salvage value are forecasts. Change either one and the annual expense changes, which gives management room for judgment.
Method choice affects comparability. Two companies with identical assets can report different profits in the same year because one uses straight-line and the other an accelerated method.
It is based on historical cost. Depreciation spreads what was paid, not the cost to replace the asset. When prices are rising, the expense can understate the real cost of maintaining the asset base.
It smooths cash outlays. Turning a lumpy purchase into steady expenses helps when reading profitability but can obscure when the next large capital purchase will hit.

Amortization spreads the cost of intangible assets, such as patents or software licenses, over their useful lives. Depreciation covers tangible assets.
Depletion allocates the cost of natural resources, such as oil reserves, timber or mineral deposits, as they are extracted.
Impairment is a one-time write-down when an asset’s recoverable value falls below its carrying value. Depreciation is a scheduled, recurring charge.
Expense vs. loss vs. liability: Depreciation is an expense on the income statement. It is not a liability, because nothing is owed to anyone, and not a loss, which arises when an asset is sold for less than its carrying value. Accumulated depreciation is a contra-asset, not a liability.
Currency depreciation: In trading and economics, a currency “depreciates” when it loses value against other currencies. The word is the same, but the concept is unrelated to accounting cost allocation.

FAQs

When does depreciation start?

Depreciation starts when the asset is placed in service, meaning it is ready and available for its intended use, not when it is ordered or paid for. In the first and last years, partial-year conventions (such as the half-year convention used under MACRS) determine how much depreciation is allowed.

What happens when a depreciated asset is sold?

The asset and its accumulated depreciation are removed from the books. The sale price is compared with the carrying value at that date. Proceeds above carrying value produce a gain, and proceeds below it produce a loss. For tax purposes, part of a gain on depreciated property may be taxed as depreciation recapture.

The Bottom Line

Depreciation matters to business owners choosing how to record equipment and to investors comparing reported profits. The method changes when expenses appear, which shifts yearly profit and taxable income while total cost stays the same. Because the charge rests on estimates and historical cost, readers should treat carrying value as unexpensed cost and look at cash flow and capital spending alongside reported earnings.