Quick answer
Depreciation is the systematic allocation of a depreciable asset’s depreciable amount over its useful life. The depreciable amount is its cost or substituted measurement less residual value. It recognizes cost as the asset’s benefits are consumed; it does not remeasure the asset to market value.
A long-lived asset can provide benefits over many reporting periods. Expensing its entire cost immediately would charge the acquisition period for benefits used in later periods. Depreciation instead allocates the cost according to how the business expects to consume those benefits. The charge is usually an expense, but depreciation of equipment used to produce another asset, such as inventory, forms part of that asset’s cost.
The depreciation amount comes from the asset’s cost, residual value, useful life, and expected pattern of use. A carrying amount is the amount at which the asset is reported at a date: its recorded cost, less accumulated depreciation and accumulated impairment losses. Impairment losses are separate reductions recorded when the amount expected to be recovered has fallen; they are not depreciation.
Depreciation inputs and estimates
- Cost
- The amount recorded when the asset is acquired and made ready for use.
- Residual value
- The expected value remaining at the end of the asset’s useful life, after relevant disposal assumptions.
- Useful life
- The period or output over which the entity expects to consume the asset’s benefits.
- Depreciable amount
- Cost less residual value—the amount allocated over the useful life.
Not every PP&E balance is depreciated. Land with an unlimited useful life is not depreciated, while a building on that land has a separate, limited life. Land with a finite period of benefit and qualifying restoration-cost components require their own allocation analysis.
Depreciation method and pattern of use
Cost and residual value determine the amount available to allocate. The method determines when that amount is recognized as depreciation. A business selects the method that best reflects the pattern in which it expects to consume the asset’s benefits; it does not select a method simply to produce the preferred profit result.
- Straight-line
- Use when the expected benefit is reasonably even from period to period. The same amount is allocated in each full period: (cost − residual value) ÷ useful life.
- Diminishing balance
- Use when the expected benefit is greater in earlier periods. A selected rate is applied to the opening carrying amount, producing a larger expense early and a smaller expense later.
- Units of production
- Use when measured output or activity is a better representation of consumption than the passage of time. Divide the depreciable amount by expected lifetime output to find a cost per unit, then multiply by actual output for the period.
Under any method, depreciation cannot reduce the asset below its stated residual value. If the normal calculation would cross that floor, the final charge is limited to the difference between opening carrying amount and residual value.
Compare three consumption patterns for one asset
Equipment costs $50,000, has a $5,000 residual value, a five-year useful life, and capacity of 100,000 units. It produces 22,000 units in the first year. A 40% diminishing-balance rate—twice the 20% straight-line rate for a five-year life—illustrates an early-heavy pattern.
Scroll horizontally to see all columns.
| Method | First-year calculation | Expense | Pattern represented |
|---|---|---|---|
| Straight-line | ($50,000 − $5,000) ÷ 5 years | $9,000 | Even benefit across the five years |
| Diminishing balance | $50,000 opening carrying amount × 40% | $20,000 | More benefit in the earlier years |
| Units of production | ($45,000 ÷ 100,000 units) × 22,000 units | $9,900 | Benefit follows measured output |
These amounts differ because the methods represent different patterns, not because one has found a different cost. All three begin with the same $45,000 depreciable amount. Over the asset’s life, depreciation stops once the applicable depreciable amount has been allocated.
At 40%, diminishing-balance depreciation leaves a $6,480 carrying amount after four years. The normal fifth-year calculation would cross the residual-value floor, so the final charge is capped at $1,480, leaving the asset at its $5,000 residual value. Total depreciation is $45,000.
Commencement and unit of depreciation
A purchase date does not by itself settle the first depreciation period. The business determines when the asset is available for its intended use, applies its supported partial-period convention, and considers whether significant parts have different consumption patterns. A building and a major component inside it, for example, may require separate lives or methods when the applicable requirements and facts support that treatment.
One month of straight-line depreciation
Maple Tech expects to use the equipment’s benefits evenly over its useful life. Equipment cost $12,000; residual value $0; useful life 60 months. The equipment was available for use on March 3, 2026. Maple’s stated policy records a full month of depreciation for assets that become available for use during the month.
($12,000 − $0) ÷ 60 months = $200 per month
March’s $200 allocation increases Depreciation Expense. Accumulated Depreciation receives the credit so the equipment’s original recorded cost remains visible while its carrying amount is reduced through a contra-asset.
Scroll horizontally to see all columns.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | 200 | |
| Accumulated Depreciation — Equipment | 200 |
Scroll horizontally to see all columns.
| Line item | Amount |
|---|---|
| Equipment, at recorded cost | 12,000 |
| Less: Accumulated depreciation | (200) |
| Equipment, net carrying amount | 11,800 |
Financial-statement effect
Scroll horizontally to see all columns.
| Statement | Account | Effect | Timing |
|---|---|---|---|
| Income statement | Depreciation Expense | Expense increases by $200; March profit decreases by $200 | For March |
| Balance sheet | Accumulated Depreciation | Contra-asset increases by $200; net equipment becomes $11,800 | At March 31 |
| Cash flow statement | Depreciation | The depreciation entry has no cash effect; it is added back in an indirect operating bridge | The separate equipment acquisition is a March investing cash outflow |
- Income statement
- AccountDepreciation Expense
- EffectExpense increases by $200; March profit decreases by $200
- TimingFor March
- Balance sheet
- AccountAccumulated Depreciation
- EffectContra-asset increases by $200; net equipment becomes $11,800
- TimingAt March 31
- Cash flow statement
- AccountDepreciation
- EffectThe depreciation entry has no cash effect; it is added back in an indirect operating bridge
- TimingThe separate equipment acquisition is a March investing cash outflow
Related but distinct concepts
- Estimate changes update future allocations when a useful life, residual value, or consumption pattern changes based on new information; prior-period expense is not restated for an estimate change.
- Impairment reduces an asset’s recorded amount when it fails the applicable recoverability test. It is not another depreciation method.
- Capital cost allowance (CCA) is the Canadian tax deduction for depreciable property, calculated by prescribed class rates. It usually differs from book depreciation, and that difference is a source of deferred income tax.