3.5 : Depreciation on Fixed Assets

Depreciation is an accounting method used to allocate the cost of tangible assets over their useful lifespan. Assets depreciate as they lose value over time due to usage, wear and tear, and technological advancements. The three main methods for calculating depreciation are the straight-line method, the written-down-value method, and the units of production method.

Most companies apply a single depreciation method to all their assets, and different depreciation approaches are often specific to certain industries.

For instance, consider a logistics company that has purchased a delivery truck with a useful life of five years. The truck will provide long-term economic benefits by facilitating deliveries, which generate revenue. However, the truck's value will diminish over time due to daily use and the availability of newer, more efficient models. The depreciation expense is spread over the five years, matching the truck's cost to the revenue it helps generate. This systematic depreciation ensures the financial statements accurately reflect the truck's declining value and present a realistic picture of the company's financial health.