In accounting, depreciation refers to the process of allocating the cost of a tangible or physical asset over its useful life or life expectancy. An asset's depreciation represents its use.
Companies can generate revenue from depreciating assets while expensing a portion of their costs each year. A company's profits can be greatly affected by not accounting for depreciation. Long-term assets can also be depreciated for tax preparation and accounting purposes.
It is expensive to acquire assets such as machinery and equipment. Rather than realizing the asset's entire cost in the first year, companies use depreciation to spread out the cost and generate revenue from it over time. Depreciation allows a company to write off an asset's value over time, notably over its useful life.
The carrying value represents the difference between the original cost and the accumulated depreciation over a period of time, so it can be used to account for declines over time in the carrying value.
The purpose of depreciation is to move an asset's cost from the balance sheet to the income statement. An asset purchase is recorded as a debit on the balance sheet to increase an asset account and as a credit to reduce cash (or to increase accounts payable) on the balance sheet. There is no effect on the income statement, where revenues and expenses are reported.