Depreciation is a phenomenon that occurs when an asset’s value decreases over time. It can be calculated for accounting, tax, and financial reporting purposes, and is shown on a company’s income statement. In effect, depreciation reduces the total earnings reported by a business in any five year period.

Depreciation is not an expense like other costs such as wages, raw materials, or rent. Instead, it’s an allocation of expenses determined by matching the cost of an asset with its expected life span. The amount of depreciation allowed each year depends on the useful life of the asset and its estimated salvage value. Because depreciation is a non-cash expense, it doesn’t reduce the amount of money a business has available to pay bills, but it does lower its taxable income.