Depreciation is an accounting method for distributing a tangible or physical asset’s cost over its usable life or expected life. Depreciation is the measurement of how much of an asset’s value has been depleted over time.
Depreciating assets allows businesses to generate income while depreciating a percentage of the asset’s cost each year it is in use. It can have a significant impact on earnings if it is not taken into consideration. Long-term investments can be depreciated for both tax and accounting purposes. Companies, for example, can claim a tax deduction for the asset’s cost, lowering their taxable income.
Depreciation is expense spread over time for the cost of a larger purchase.
For example, if you purchase machine for your business that cost $50,000 and you expect it to last for 5 years, then the cost is really $10,000 per year.
Since accrual basis accounting includes matching revenue and expenses, if you count the whole $50k in the year you buy it, that year profit looks bad.
Then next year when you are still using the machine but have no cost for it, your profit may look very good, but neither year is showing accurate picture because in reality you should have $10k of that expense in each of 5 years.