what is depreciation?

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what is depreciation?

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I sold you a toy for $10, a few weeks later you want to sell it back to me because you want a different toy, I’ll only give you $7 cause you played with it

The value of the item you bought goes down over time.

After you’ve owned your car for 5 years it isn’t worth as much as when you first bought it.

Depreciation means “decrease in value over time”. For example, the more you drive a car, the less like-new it’ll be: the parts will be worn, the body will have little dings and dents, etc. So it isn’t worth as much as it was when it was new.

In accounting terms it is a non-cash expense. To use the example others have used, say a car. A company has to buy a new delivery vehicle every 5 years. It wouldn’t make sense to say they have a $20k expense once every 5 years. That would make their earning unnecessarily lumpy. What they do instead is when they purchase the car they account for the purchase as a $20k asset. Every year they take a $4k depreciation expense. So the entire purchase ends up being an expense. Just 1/5 every year instead of 100% 1 year and 0% the other 4.

It is the reduction in value of a durable good as it ages. It’s why a new $30k car is only worth $15k 5 years later.

There is also an accounting principal to account for this, allowing businesses to more evenly spread the cost out over time vs. having $30k expenses every 5 years.