
Depreciation represents the decline in value of an asset over time due to factors such as wear and tear, obsolescence, or damage. For example, a piece of machinery may depreciate if it becomes less efficient or a vehicle may lose value following damage or as it ages. This concept is crucial not only in practical terms but also in accounting, where it helps distribute the cost of an asset over its expected useful life. This approach prevents large expenditures from distorting the financial statements in the period they occur, spreading these costs to match the asset's period of utility.
In accounting, depreciation is used as a way to allocate the cost of tangible assets over their useful lives, making it an essential element in financial reporting and tax calculations. This systematic expense recognition helps companies smooth out earnings over time and offers tax advantages by reducing taxable income each year the asset depreciates.