Decrease of value in assets. A concept of Financial Reporting.
Every year an asset looses some value based on the lifetime on the asset. Different assets have different lifetimes.
Stone to Gold
When adding depreciation into the price calculations and the customers pay that price then you turned stoned to gold. Since the depreciation is never leaving the cash account you “made up” profits.
Where to Find in Income Statement
- Depreciation is not in a single account in Income Statement
- Depreciation of R&D Building is under R&D expenses, etc.
Example - Machine
- purchase of machine at 20
- BS: ppe +20, cash -20
- CF: -20
- PL: 0 → buying stuff does not change the profit
- 5 years useful live → annual depreciation of 4 (just one year here)
- BS: ppe -4
- CF: 0 → depreciation does not “cost” anything
- PL -4
- after all 5 years (fully depreciated)
- BS: ppe = 1 (just to mark that it exists, but it is 0 actually)
- PL: -20 (accumulated)
- CF: 0 → still nothing
- selling after 4 years at 7
- CF +7
- BS: ppe -4, cash +7, retained earnings +3
- PL: +3 (income 7 - expense 4)
- Balance Sheet Sum +3 (from PL)
Example - Machine, but Fair Value
→ Fair Value
- book value is 1.000, Fair Value is 1.200
- BS: ppe +200, retained earnings +200
- CF: 0 →
- PL: +200 → write-up = income
Example - Machine, Residual Value
- 50k for 10 years
- depreciation would be 5k (50k / 10y)
- expected residual value is 10k
- depreciation would be 4k ((50k - 10k) / 10y)