Define ‘depreciation’

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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There are two definitions for “depreciation” in the context of business.

First, depreciation can be defined as the loss in value of some asset because of bad conditions in the market.  This can, for example, happen to real estate.  If you buy a piece of real estate and then the market crashes, that real estate can lose value.  When it does, we say it has depreciated.

Second, depreciation is the process of allocating the cost of a piece of equipment over a long period of time.  For example, let us imagine that a firm buys a piece of equipment that costs $1 million.  They expect the equipment to last them 10 years.  Therefore, they will, for accounting purposes, divide the purchase price by the expected life of the equipment.  By doing so, they make the cost of the equipment match up with the products that it is helping to make.  This prevents firms from looking as if they have had a terrible year simply because they have happened to buy expensive capital equipment during that year.

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