Depreciation and the Benefits to a Business

Depreciation is a very important item on any financial statement. Depreciation is the process of dispersing out the cost of an asset over its useful life to a business. Businesses for tax purposes, can deduct the cost of the physical assets they purchase as business expenses; but, businesses must depreciate these assets in agreement with IRS rules on how and when the deduction may be taken based on what the asset is and the life expectancy of the asset.
Depreciation is used in accounting to try to match the expense of an asset to the income that the asset earns for the company.
Here are some examples of items that can be depreciated: buildings, machinery, equipment, computers, outdoor lighting, parking lots, cars, and trucks. During each accounting period a portion of the cost of these assets is being used up. The portion of what is being used up is reported as "Depreciation Expense" on the income statement. In effect depreciation is the transfer of a portion of the asset's cost from the balance sheet to the income statement during every year of the asset's life.
Depreciation can be calculated and reported based upon two accounting principles: the cost principle and the matching principle. The cost principle requires that the "Depreciation Expense" to be reported on the income statement, and the asset amount that is reported on the balance sheet, should be based on the original cost of the asset. The matching principle requires that the asset's cost be allocated to "Depreciation Expense" over the life expectancy of the asset. What this means is that the cost of the asset is divided up with some of the cost being reported on each of the income statements issued during the life of the asset. By assigning a portion of the asset's cost to various income statements, the accounting professional is matching a portion of the asset's cost with each period in which the asset is used.
There are a few types of depreciation: Straight-line, Sum-of-the-year's digits, Double-declining balance, Modified accelerated cost recovery system (MACRS). I will briefly define them, the straight-line depreciation method is done by taking the purchase price of an asset subtracted by the salvage value divided by the total years the asset can realistically be a benefit to the company. The straight-line method spreads out the cost of an asset evenly over its life span. The Sum of the Year's Digits method results in a more accelerated write-off than straight line, but less than double declining-balance method. Under the Sum-of-the-year's digits method annual depreciation is determined by multiplying the Depreciable Cost by a schedule of fractions.