Depreciation

Financial Dictionary -> Investing -> Depreciation

Depreciation (the opposite of appreciation) is an accounting term that refers to the decrease in value of an asset over time in comparison with its historical or purchase price, such as a home or building, although it is not directly linked to the market value of the asset and is more to do with its internal value to the business or person who owns it. One of the main reasons to calculate depreciation and use it in accounts is to simply "window dress" the business' finances in order to decrease the tax on income, (this is neither illegal nor frowned upon).

It is explained that depreciation occurs over time due to general wear and tear on the building such as deterioration because of age, advances in technology or the depletion of its resources (land containing bon renewable resources). Using a hypothetical example, if you bought boat to export goods and then planes were invented your boat would have lost value because of technological advancement.

This depreciation amount is included in your financial records as a cost and therefore lowers your profit margin. This in turn means you have less tax to pay on the profits, meaning more retained profit (in theory) and less to pay to the tax man. To people outside of business this can seem quite a sly and unethical business practice, although if done by a qualified accountant and not blatantly exaggerated then depreciation is a legally and morally accepted practice that all business use and are entitled to use.

When calculating depreciation it is standard practice for accountants to make it an annual occurrence, rather than a monthly one, and when the calculation is undertaken it is compared with the original value of the asset. This historical value minus the deprecation amount is called the book value.