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L.2 · INTERMEDIATE · 2 MIN

Depreciation: Spreading the Cost of Assets

When a company buys a long-lived asset, it does not expense the entire cost in year one. Instead, it spreads the cost over the asset's useful life. This is depreciation.

Quiz · 5 questions ↓

Formula

Annual Depreciation = (Cost - Salvage Value) / Useful Life

Key point

Depreciation is a non-cash expense. The cash left the building when the asset was purchased. Depreciation merely allocates that cost over time for matching purposes.

Key insight

This is why EBITDA (earnings before depreciation) is popular. It removes the accounting allocation to show cash-level profitability. But ignoring depreciation entirely is dangerous, because assets DO wear out and must be replaced.

Check-in

A company buys a machine for $10M with 10-year useful life, no salvage value. Straight-line depreciation = $1M/year. Actual machine is still running efficiently at year 12 — is the company still earning from it?
Check your understanding

Sit with the ideas.

A company buys a machine for $1,000,000 with a 10-year useful life and zero salvage value. Using straight-line depreciation, what is the annual depreciation expense?

Why:
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Other lessons in this course.

  1. 01Accrual vs Cash Accounting
  2. 02Depreciation: Spreading the Cost of Assets— reading now
  3. 03Stock-Based Compensation: The Hidden Cost
  4. 04Adjusting Entries: Why Period-End Matters
  5. 05Revenue Recognition: The ASC 606 Five-Step Model
  6. 06Bad Debts: When Customers Don't Pay
  7. 07Inventory: FIFO vs. LIFO and Why It Matters
  8. 08PP&E Deep Dive: Four Depreciation Methods and Asset Disposal
  9. 09The Cash Flow Statement: Follow the Actual Money
  10. 10DuPont Analysis: Decomposing Return on Equity
  11. 11EPS and Dilution: The Most Watched Number on Wall Street
  12. 12Deferred Taxes: Why Tax Expense Differs from Taxes Paid
  13. 13Lease Accounting: The Hidden Debt That Isn't So Hidden Anymore
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