Depreciation - What does depreciation mean? Read more here

Learn what depreciation is and how it can help your business allocate costs over time. Gain insights into how you can effectively use depreciation to improve your accounting and financial planning

How depreciation works: allocating costs and asset depreciation over time

What is depreciation

Depreciation is an accounting method used to allocate the cost of an asset over its expected lifespan. It accounts for the decrease in the value of an asset over time, providing a more accurate representation of a company’s financial situation.

Depreciation refers to the process of reducing the value of a tangible or intangible asset on a company’s balance sheet over time. This reflects wear and tear, aging, and obsolescence. Depreciation is commonly applied to assets such as buildings, machinery, vehicles, and software.

Use of depreciation in accounting

In accounting, depreciation is used to spread the cost of an asset over its useful life. This helps match the costs to the revenue generated by the asset. By depreciating an asset, companies can avoid large one-time expenses and instead distribute the costs over several years.

There are various methods to calculate depreciation, but the most common are straight-line depreciation and declining balance depreciation.

Example of depreciation

To illustrate how depreciation works in practice, let’s take an example using straight-line depreciation.

Straight-Line depreciation

Straight-line depreciation is the simplest method, where the value of the asset is depreciated by the same amount each year over the asset’s useful life.

Let’s say your company purchases a machine for 100,000 DKK, with an expected lifespan of 5 years and a residual value of 10,000 DKK. The annual depreciation is calculated as follows:

Purchase price: 100,000 DKK
Residual value: 10,000 DKK
Lifespan: 5 years

Annual depreciation = (Purchase price - Residual value) / Lifespan
Annual depreciation = (100,000 DKK - 10,000 DKK) / 5 years
Annual depreciation = 90,000 DKK / 5 years
Annual depreciation = 18,000 DKK

In this example, your company would depreciate 18,000 DKK each year for 5 years.

Learn what depreciation is and how it can help your business allocate costs over time. Gain insights into how you can effectively use depreciation to improve your accounting and financial planning