Depreciation

Depreciation in the Income Statement is a charge against income based on an estimate of the percentage of the original cost for fixed assets that has been used up in the production process during the period covered by the Income Statement.

Depreciation is not a cash expense like Labor and material costs; it is simply a bookkeeping entry on the Balance Sheet and on the Income Statement. The cash expense for fixed assets is incurred at the time of purchase.

On the Balance Sheet, Gross Fixed Assets (capitalized purchases of property, plants, and equipment) are listed at their purchase price. Accumulated Depreciation (sum of all depreciation charges over the life of the assets currently on the company's Balance Sheet) is deducted to arrive at Net Fixed Assets. Net Fixed Assets can be considered as an estimate of the value of those assets for the remainder of their useful lives.

On the Income Statement, the total Depreciation for the period for all Capitalized Assets is deducted from earnings as an Operating Cost.

For example, the piece of equipment may have an estimated useful life of five years and, therefore, will have no value at the end of the five years. Using a straight-line depreciation method, the annual amount that the company may deduct is ($500,000 - $0) / 5 yrs. = $100,000. There are several different depreciation methods and any accounting text can provide a more detailed discussion of their calculations and uses.