Definition of Depreciation

Depreciation is the gradual conversion of the cost of a tangible capital asset or fixed asset (excluding land because it has unlimited life) into depreciation expense over the asset's estimated useful life. The objectives of computing depreciation are to:

• Reflect reduction in the book value of the asset due to obsolescence (functional depreciation) and wear and tear (physical depreciation)
• Spread a large expenditure (purchase price of the asset) proportionately over a fixed period to match revenue received from it
• Reduce the taxable income by charging the amount of depreciation against the firm's total income. In effect, charging of depreciation means the recovery of invested capital, by gradual sale of the asset over the years during which output or services are received from it.

Depreciation is the cost allocation for plant & equipment over time. It is not to be confused with cost allocation as it is not a measure of a decline in fair value of an asset.