What Is Depreciation?

Patrick Curtis

Reviewed by

Patrick Curtis WSO Editorial Board

Expertise: Investment Banking | Private Equity

Depreciation is when any asset is deemed to have reduced in value. No tangible asset can last indefinitely and therefore at some point, the asset will no longer be usable and will have to be recorded as a loss on the income statement. Depreciation allows a firm to allocate a percentage of that loss to different periods.

One of the reasons for using depreciation is so that when a very expensive asset such as a factory is no longer useful and is worthless, the company does not have to record a massive loss in a single period which would drastically affect performance. Depreciation allows this large loss to be allocated to lots of different periods in small amounts.

A business example of depreciation is if a company was to buy a new factory for $10 million and the useful life of that factory was 25 years, each year the factory would have effectively depreciated by $400,000 ($10,000,000 / 25) and this would be recorded as a loss each year rather than having no change in value and then a $10 million loss in year 25.

The typical real-world example of depreciation is whenever you buy a new car, it is deemed to have depreciated by up to 50% as soon as you drive it away from the dealer. Even though the car has not changed, it is worth less.

Related Terms

Return to Finance Dictionary

Patrick Curtis

Patrick Curtis is a member of WSO Editorial Board which helps ensure the accuracy of content across top articles on Wall Street Oasis. He has experience in investment banking at Rothschild and private equity at Tailwind Capital along with an MBA from the Wharton School of Business. He is also the founder and current CEO of Wall Street Oasis. This content was originally created by member WallStreetOasis.com and has evolved with the help of our mentors.