Why depreciation matters to a first-time founder
Depreciation spreads an asset’s cost across the periods that use it, affecting profit and the balance sheet without matching a current cash payment. Choosing unsupported useful lives or residual values can misstate performance. Tax deductions may follow separate rules from accounting depreciation.
Examples of depreciation
A company buys machinery for $52,000, expects a $4,000 residual value and plans to use it for four years. Straight-line depreciation is $12,000 a year: the $48,000 depreciable amount divided by four. The initial cash purchase and annual accounting expense occur at different times.
Common misunderstanding
Depreciation does not measure an asset’s market-price decline. It allocates depreciable cost using an accounting estimate, even if market value rises. Impairment is a separate reduction when an asset’s recoverable amount falls below its carrying amount, subject to the applicable reporting framework.
When to use it
Set a method, useful life and residual value when placing a material tangible asset into use, then review estimates when circumstances change. Use the figures in budgets and asset records, but consult an accountant about reporting and local tax allowances rather than assuming one schedule serves both.