What is Depreciation?
Depreciation is the gradual reduction in the value of a tangible asset
over time due to usage, wear and tear, aging, or technological obsolescence.
In accounting, it represents the allocation of an asset's cost over its useful life.
Definition
Depreciation = spreading the cost of an asset over its useful life, matching the expense
to the periods in which the asset generates revenue.
Example: A company buys a machine for ₹10,00,000 and expects to use it
for 10 years. Instead of recording ₹10,00,000 as an expense in year one, depreciation
spreads that cost — ₹1,00,000 per year — over the asset's life.
Types of Assets That Depreciate
- 🏭 Machinery & factory equipment
- 🚛 Vehicles (vans, trucks, cars)
- 🏢 Buildings & structures
- 🪑 Furniture & fixtures
- 💻 Computers & electronics
Assets That Do NOT Depreciate
- 🌍 Land (appreciates or holds value)
- 🥇 Gold & precious metals
- 📈 Certain financial investments
- 🏺 Antiques & collectibles
🚐 Real-Life Example — Delivery Van
A logistics company buys a van for ₹12,00,000. Here is how its value changes:
Wear and tear, mileage, and aging reduce the van's market value every year.
That annual reduction — recorded in the books — is depreciation.
Why is Depreciation Important?
Depreciation is not just an accounting entry — it is a fundamental tool for
managing a business's financial health accurately.
- Accurate Profit Calculation: Matches the cost of an asset to the revenue it helps generate.
- True Asset Value: Shows the real (book) value of assets on the balance sheet.
- Tax Reduction: Reduces taxable income, which lowers the tax burden legally.
- Future Planning: Helps businesses budget for asset replacement in advance.
- Investor Confidence: Accurate financial statements build trust with investors and lenders.
🏭 Business Story — Factory Owner
A factory owner bought 10 machines worth ₹50 lakh and initially ignored depreciation.
After 5 years, machines became outdated, repairs increased, and profits appeared inflated.
After adopting proper depreciation accounting, financial statements became accurate,
tax planning improved, and machinery replacement became systematic and stress-free.
Methods of Depreciation
There are two primary methods used in Indian accounting (and globally) to calculate
depreciation. The right method depends on the nature of the asset.
1. Straight Line Method (SLM)
Under SLM, an equal fixed amount of depreciation is charged every year
throughout the asset's useful life. The depreciation expense remains constant — hence the
name "straight line."
Best suited for
Furniture, buildings, office equipment — assets that are used evenly over time.
Worked Example:
- Laptop Cost = ₹1,00,000
- Residual (Scrap) Value = ₹10,000
- Useful Life = 5 years
2. Written Down Value Method (WDV)
Under WDV (also called Diminishing Balance Method), depreciation is calculated
on the remaining book value each year — so the charge is higher in early
years and lower later.
Best suited for
Machines, cars, electronics — assets that lose value rapidly in early years.
Worked Example — Machine Cost ₹1,00,000 at 20% p.a.:
SLM vs WDV — Comparison Table
| Feature |
Straight Line (SLM) |
Written Down Value (WDV) |
| Depreciation Amount |
Fixed every year |
Reduces each year |
| Calculation |
Simple |
Slightly complex |
| Best suited for |
Stable, long-life assets |
Fast-aging assets |
| Profit impact in early years |
Equal expense |
Higher expense initially |
| Tax benefit |
Spread evenly |
Higher in early years |
| Allowed under Indian Tax Law |
Yes (Companies Act) |
Yes (Income Tax Act) |
Benefits & Tax Impact of Depreciation
Tax Benefit — Worked Example
Because depreciation is an allowable expense, it directly reduces your taxable income:
- Profit before depreciation: ₹10,00,000
- Depreciation expense: ₹2,00,000
Key Insight
Depreciation is a non-cash expense — no money leaves the business.
Yet it legally reduces your tax bill every year.
Depreciation in Daily Life
You experience depreciation every day without realising it:
- 📱 A smartphone bought for ₹80,000 may sell for only ₹45,000 after 2 years (≈44% drop)
- 🚗 A car loses 15–25% of its value in the first year alone
- 💻 Laptops typically lose 30–40% of value within 2 years
- 🛋️ Office furniture depreciates more slowly — around 5–10% per year
💡 Did You Know?
- Commercial airplanes are depreciated over 20–25 years by airlines.
- Large companies like Tata or Infosys compute depreciation for thousands of assets simultaneously.
- Technology products depreciate up to 5× faster than industrial buildings.
- Some smartphones lose 30–40% of their resale value in the very first year.
- Certain antiques and artworks appreciate rather than depreciate.
🍽️ Restaurant Equipment Example
A restaurant owner invested ₹15 lakh in ovens, refrigerators, and furniture.
After 6 years, equipment efficiency had dropped, electricity bills rose, and
repair costs were eating into margins.
Proper depreciation records helped the owner:
- ✅ Replace old equipment at the right time — not too early, not too late
- ✅ Plan capital investments in advance
- ✅ Control business costs and present accurate accounts to lenders
Quick Quiz — Test Your Understanding
Check how well you've grasped depreciation with these 5 questions:
Question 1 of 5
What does depreciation mean in accounting?
- A. Increase in asset value
- B. Reduction in asset value over time ✅
- C. Increase in company sales
- D. Profit earned by a company
✅ Correct Answer: B
Question 2 of 5
Which asset typically does NOT depreciate?
- A. Car
- B. Machinery
- C. Land ✅
- D. Computer
✅ Correct Answer: C
Question 3 of 5
Which depreciation method charges an equal amount every year?
- A. WDV Method
- B. Straight Line Method ✅
- C. Market Value Method
- D. Profit Method
✅ Correct Answer: B
Question 4 of 5
Why do businesses record depreciation?
- A. To inflate profits
- B. To reduce asset cost incorrectly
- C. To show accurate financial position ✅
- D. To avoid accounting work
✅ Correct Answer: C
Question 5 of 5
A machine costs ₹2,00,000 with a useful life of 5 years and no scrap value. What is the annual SLM depreciation?
- A. ₹20,000
- B. ₹30,000
- C. ₹40,000 ✅
- D. ₹50,000
✅ Correct Answer: C
Frequently Asked Questions (FAQ)
These are the most common questions people ask about depreciation.
Answers are structured to appear in Google's Featured Snippets and People Also Ask boxes.
What is depreciation in simple terms?
+
Depreciation is the gradual reduction in the value of an asset over time due to wear and tear, usage, aging, or technology becoming outdated. In accounting, it means spreading the cost of an asset across its useful life so that expenses match the periods in which the asset helps generate revenue.
What is the difference between SLM and WDV depreciation?
+
Under the Straight Line Method (SLM), the same fixed depreciation amount is charged every year. Under the Written Down Value (WDV) method, depreciation is calculated on the reducing book value, so the charge is higher in early years and decreases over time. SLM suits stable assets like furniture; WDV suits fast-aging assets like machinery or cars.
Is depreciation a cash expense?
+
No. Depreciation is a non-cash accounting expense. No money actually leaves the business when depreciation is recorded. Instead, the asset's book value is reduced on the balance sheet each year, and the same amount is shown as an expense in the Profit & Loss account.
How does depreciation reduce income tax?
+
Depreciation is an allowable deduction under the Income Tax Act. When you subtract depreciation from your business profit, the taxable income decreases. For example, if your profit is ₹10,00,000 and depreciation is ₹2,00,000, you only pay tax on ₹8,00,000. This is a legal and widely used tax-planning strategy for businesses.
Which assets do not depreciate?
+
Land does not depreciate because it has an unlimited useful life and often appreciates in value over time. Gold, certain financial investments, and collectibles/antiques also typically do not depreciate. In fact, many of these assets can increase in value over time.
What is useful life in depreciation?
+
Useful life is the estimated number of years an asset is expected to remain productive and usable by the business. For example, a computer might have a useful life of 3–5 years, whereas a building could have a useful life of 30–50 years. Under the Companies Act, 2013, Schedule II provides standard useful-life figures for common asset types in India.
What is residual value or scrap value?
+
Residual value (also called scrap value or salvage value) is the estimated amount a business expects to receive when selling or scrapping an asset at the end of its useful life. This amount is deducted from the asset's cost before calculating SLM depreciation. If no residual value is expected, the full cost is spread over the useful life.
Can depreciation be claimed on intangible assets?
+
Yes, but it is called amortisation for intangible assets (such as patents, trademarks, software licences, and goodwill), not depreciation. The concept is the same — spreading the cost over the asset's useful life — but the term differs. Under the Income Tax Act in India, intangible assets are depreciated at 25% under the WDV method as part of Block of Assets.
What happens when an asset is fully depreciated?
+
When an asset is fully depreciated, its book value equals its residual value (or zero if no scrap value was estimated). The asset may still be in use; it just has no further depreciation charged. When it is eventually sold or scrapped, any amount received above the book value is recorded as a profit on disposal, and any shortfall is a loss.
Why do cars depreciate faster than buildings?
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Cars depreciate faster because they have shorter useful lives (typically 8–10 years), face heavier wear and tear, and lose desirability quickly as newer models are released. Buildings, on the other hand, have useful lives of 30–60 years, face minimal technological obsolescence, and the land component does not depreciate at all.
Conclusion
Depreciation is one of the most important concepts in accounting and finance.
It ensures that a business's financial statements reflect reality — not an inflated
picture of profits and assets.
Whether you are a student, small business owner, or investor, understanding depreciation
helps you read financial statements clearly, make smarter decisions, and plan your
finances with confidence.
