Most business owners have heard the term, but many do not truly understand. However, depreciation is an important component of accounting. Fixed assets are those operating assets that are not for sale or that you may lease or rent. These fixed assets are your businesses buildings, machinery, office equipment, vehicles, etc that have been purchased or financed. Depreciation expense is the spreading of the expense over the useful life of the fixed assets for a period of years. For example, a vehicle is considered to have a useful life of five years. Therefore, the idea is to spread a percentage of the cost over all five years versus up front in year one.
Although, depreciation is a real expense, it is different from your other business expenses. When you purchase inventory, office supplies or pay insurance, that is a true outlay of cash. Depreciation expense is that years’ portion of the business’s fixed asset recorded as a transactional journal to offset revenue and determine the company’s profit. The depreciation expense will vary with the cost of the business’s fixed assets.