Depreciation |
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Depreciation is the decrease in value of a tangible asset or assets over time
Depreciation is an accounting term used to rectify the cost of tangible assets with the decrease in value over their useful life (from normal use, wear and tear, or just the passage of time). It is reported as an expense on the income statement (usually as "depreciation" though often lumped together with amortization or sometimes in an overarching category like "other"). However, since it is a non-cash expense, depreciation is never actually paid for (no cash changes hands) and, as such, is added back to the total cash from operating activities on the cash flow statement. Thus, depreciation actually increases a company's free cash flow while decreasing earnings.
There are different methods of depreciating assets and each will provide different values for the asset over time. As such, there is some controversy over how companies choose to depreciate their assets, as different methods will provide different values. Some common methods of depreciation include straight-line depreciation, declining balance depreciation, and unadjusted depreciation. Regardless of what method of depreciation is chosen by the company, the total value of depreciation over the asset's lifetime will be the same. That is, the different methods simply provide different schedules for depreciation.
It should be noted that depreciation is not the spreading of an asset's cost over a period of time, but rather as a means of accounting for the item's decrease in value following initial purchase. The purchase of the item itself is calculated as an expense on the income statement at the time of purchase.