Depreciation is a planned, gradual reduction in the recorded value of an asset over its useful life by charging it to expense. Depreciation is applied to fixed assets, which generally experience a loss in their utility over multiple years. The use of depreciation is intended to spread expense recognition over the period of time when a business expects to earn revenue from the use of an asset.
For example, an organization buys a truck for $50,000 and expects to use it for the next five years. Accordingly, the firm charges $10,000 to depreciation expense in each of those five years. This charging to expense in a consistent, even amount over time is called the straight-line method. If the firm had instead elected to recognize a larger expense earlier in the life of the truck, it would use an accelerated depreciation method, which reduces the amount of reported income early in the life of an asset. Yet another variation is to depreciate based on the actual usage of an asset, which is addressed by the units of production method.
The typical depreciation entry is a debit to depreciation expense and a credit to accumulated depreciation. Accumulated depreciation is a contra asset account; it is paired with and offsets the fixed assets line item in the balance sheet.
The recognition of depreciation expense is unrelated to cash flows, so it is considered a noncash expense. Instead, the only cash flows related to a fixed asset are when it is acquired and when it is eventually sold.