There are many different methods for calculating depreciation By far the most common of these is straight line depreciation However, other methods do exist We'll come back to those but let's have a look at straight line depreciation in a bit more detail Straight line depreciation says that the periodic depreciation expense per asset is the same each year So if I buy an asset for 10, it's going to last me for 5 years Then I'm going to depreciate it 2 each year Now the calculation for this is you take the cost (10), minus the salvage value (the amount you might sell it for) In my examples that was 0 and you divide it by it's useful life 5 years 10 divided by 5 years equals depreciation expense of 2 each period Now importantly, it is 2 every single period for those 5 periods, it's the same depreciation expense If we go to the other depreciation methods on the right, the big difference we see is that the periodic depreciation expense may vary from period to period Examples here might include reducing balance depreciation method or double declining depreciation method However, important thing to realize is that whatever depreciation method you use, it has the same economic cost to the company You still bought it for 10, the cash cost to your company was 10 You still sell it for 0 at the end, you got five years of use from it The value that you put on it during it's life, maybe one method has it valued at 4 another method that has it value at 5 and another method has it valued at 6, who cares? The actual economic cost to the company is the same regardless of your depreciation method Another important thing to realize is that the accounting depreciation has no cash tax effect Well what does this mean? The accounting rules that you have used, maybe US GAAP, Japanese GAAP, UK GAAP, IFRS Whatever you have used to come up with your depreciation does not affect the amount of cash tax that you pay Why is this? Because the tax authorities to not recognize your accounting deprecation Instead they come up with their own value for depreciation Let's look at a depreciation example Here we have an asset that we have purchased for 100,000, that's the cash cost to the company I now need to workout what my depreciation expense is going to be each year I know it's going to have a life of 5 years and a salvage value of 0 So I'll take the initial cost 100,000 subtract the salvage value 0 (so it's still 100,000) and divide it by the 5 years I know my depreciation expense will be 20,000 each period So the value after year 1 will have dropped to 80,000. 20,000 has thus be depreciation that goes to the income statement And a similar thing happens in the year 2, the value drops to 60,000 and 20,000 goes off to the income statement And the same thing in year 3, 4 and 5 and by the end of year 5 the assets value is now 0 So how much has been depreciated? It's the full 100,000 And what we have done is we have expense 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 it all of its value into that year's income statement in year 1 But I only really used 1/5th of its value that year to produce products and then sell them So that means I'm only going to put 1/5th of its value into the year 1 income statement, for all those sales So then the next year, we used another 5th of its value to produce products and then sell them So we'll put another 5th of its value in the year 2 income statement along with the year 2 sales And the same happens in years 3, 4 and 5 So you spread the value 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