The idea of depreciation is a strange one to grasp. It’s an expense that you don’t see, but it plays into your business nonetheless. Just like the plot twists in Lost, this unknown factor can be frustrating and make no sense at times-until we understand its purpose!
Long-term operating assets that are not held for sale in the course of business, such as real estate and machinery, can be classified under fixed assets.
The idea is to charge a fraction of the total cost each year that an asset is used instead of just allocating it in its first use. This way, during every year that equipment or cars are being used for business purposes, there will be some expense allocated to depreciation which might not have otherwise been charged if The buyer assigned the entire price at once.
Depreciation is a real expense but not necessarily a cash outlay. When you buy fixed assets like machinery or buildings to stay competitive as an organization, they need to be replaced eventually when they wear down and become obsolete. The depreciation of these items will show up on the balance sheet every year until it has been fully depreciated for accounting purposes – this can take years, depending on how long it takes for your company’s equipment/buildings to have deteriorated by that point.
Depreciation is different from other expenses deducted for profit; the depreciation expense recorded in a reporting period doesn’t require any true cash outlay.