There are many different methods for calculating depreciation.

The most common of these is straight-line depreciation. However other methods do exist.

Let's look at a depreciation example using straight line depreciation.

Here we have an asset that we have purchased for 100,000. That's the cash cost to the company.

I now need to work out what my depreciation expense is going to be each year.

Straight line depreciation method says that the periodic depreciation expense per asset is the same each year. I know this asset is going to have a life of five years and a salvage value of 0 i.e. I don't expect to be able to sell it for anything at the end of its life.

So I'll take the initial cost of 100,000.

Subtract the salvage value of 0 so it's still 100,000 and divide by the 5 years.

I know my depreciation expense will be 20,000 each period.

So the value of the asset at the end of year one will have dropped to 80,000.

20,000 is thus the depreciation that goes to the income statement as an expense.

And a similar thing happens in year 2 the value of the asset drops to 60,000 at the end of year 2 with 20,000 depreciation going to the income statement for year two.

And the same thing in years three, four and five.

By the end of year 5 the assets value is now 0 the the asset has been fully depreciated.

So how much has been depreciated it's the full 100,000 and what we have done is we have expensed the asset over the period of benefit.

So what does that mean? Well, if you think that 100,000 let's say it was for a machine.

Did I use all of its value in the first year to help me produce and sell products that year? Well, no, if I had I would have put all of the 100,000 value into that year's income statement as an expense in year one.

But I only really used one fifth of its value that year to produce products and then sell them.

So that means I'm only going to put one fifth of the assets value into the year one income statement for all of those sales and then next year. We use another fifth of its value to produce products and sell them. So we'll put another fifth of its value in the year two income statement along with the year to sales and the same happens in years three, four and five.

So you spread the cost of the asset? Over the period that we've got benefit from it i.e.

5 years worth of producing products to then sell them.