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What is depreciation in simple words?
In simple words, depreciation is the way we measure how a physical object loses its value over time.
Think of it as the "cost of using" something. Bookkeeping and Accounting Services Knoxville, the moment you drive it off the lot, it is worth less than what you just paid. A year later, it’s worth even less because of the miles you've driven and the general wear and tear. That drop in value is depreciation.
The "Bouncy House" Example
Imagine you start a party business and buy a professional bouncy house for $10,000.
You expect this bouncy house to last for 10 years before it gets too patched up to use.
In accounting, it wouldn't be fair to say you "lost" $10,000 the day you bought it, because you still have the bouncy house!
Instead, you say it costs you $1,000 every year to own it ($10,000 divided by 10 years).
That $1,000 is your annual depreciation. It allows you to spread the big cost over all the years the item actually helps you make money.
Why does depreciation happen?
There are three main reasons things lose value:
Wear and Tear: Physical parts break down or get old (like tires on a truck or a battery in a laptop).
Obsolescence: New technology makes the old version less desirable (like an iPhone from five years ago).
Usage: The more you use something, the closer it gets to the end of its life (like a printer that can only print a certain number of pages).
Why do we care about it?
Even though you aren't "paying" cash for depreciation every month, it matters for two big reasons:
Taxes: The government sees depreciation as a business expense. Because it's an "expense," it lowers your reported profit, which means you pay less in taxes.
Planning: It reminds a business owner that their equipment won't last forever. By tracking depreciation, they know they need to save up money to buy a replacement in the future.
Important Note: Land Never Depreciates
In the world of Accounting Services Knoxville, land is the one exception. While a building on the land will eventually crumble and need replacing, the dirt itself is considered to have an "unlimited life." Therefore, you never record depreciation on land.
