How Depreciation Expense Appears in the Income Statement

Depreciation expense represents the systematic allocation of the cost of long-term assets over the periods that benefit from their use. It translates the physical consumption, wear and tear, technological obsolescence, or time-based reduction in value of Property, Plant, and Equipment (PP&E) into a recurring operating expense.

Both IFRS and US GAAP require depreciation to be recognized in the income statement each period, ensuring that reported profit reflects the economic reality of using long-term productive assets. Depreciation affects operating margins, taxable income, and cash-flow reporting, making it a central concept in both financial analysis and management accounting.

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Depreciation expense reflects the cost of using long-term productive assets over their useful lives.

Depreciation arises whenever a company acquires long-lived tangible assets—such as buildings, machinery, vehicles, or equipment—that are used in operations for more than one period. Since these assets deliver benefits gradually, their cost must also be recognized gradually.

The periodic depreciation charge reduces the carrying value of assets on the balance sheet and records an expense that matches the consumption of economic benefits. This application of the matching principle ensures that the cost of PP&E is aligned with the revenue it helps generate.

Depreciation does not involve an immediate cash outflow; rather, it spreads a historical cost across future periods. Because of this, depreciation plays a major role in performance metrics, key ratios, and tax planning strategies.

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IFRS and US GAAP prescribe similar principles but differ in componentization and depreciation flexibility.

IFRS (IAS 16 – Property, Plant and Equipment)

Under IFRS, depreciation must reflect the pattern in which an asset’s future economic benefits are consumed. IFRS requires component depreciation, meaning significant parts of an asset with different useful lives must be depreciated separately.

Companies may choose among methods such as:

• Straight-line depreciation

• Units of production

• Diminishing balance / reducing balance

IFRS emphasizes periodic reassessment of useful lives and residual values, ensuring depreciation remains aligned with actual usage.

US GAAP (ASC 360 – Property, Plant, and Equipment)

Under GAAP, companies also use systematic depreciation methods, but component depreciation is optional and less commonly applied.

Depreciation methods typically include:

• Straight-line

• Accelerated methods (Double-Declining Balance, SYD)

• Units of production

US GAAP generally requires consistency in method selection unless asset-use patterns justify a change.

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Depreciation Recognition and Methods Compared

Aspect	IFRS Treatment	US GAAP Treatment
Component Depreciation	Required	Optional
Depreciation Methods	Straight-line, units of production, diminishing balance	Straight-line, accelerated methods, units of production
Useful Life Review	Annual reassessment required	Review only when indicators arise
Residual Value	Required; reassessed regularly	Required; reassessed only if necessary
Pattern of Use	Must reflect economic consumption	Must be systematic and rational

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Journal entries demonstrate how depreciation affects both the income statement and balance sheet.

Depreciation is recorded through a non-cash adjusting entry at the end of each period.

Recording periodic depreciation:

• Debit: Depreciation Expense

• Credit: Accumulated Depreciation

Accumulated depreciation is a contra-asset account that reduces the asset’s carrying value on the balance sheet.

Asset disposal example:When an asset is sold or retired, accumulated depreciation is removed, and any gain or loss is recognized.

• Debit: Cash (if sold)

• Debit: Accumulated Depreciation

• Credit: PP&E

• Debit/Credit: Gain or Loss on Disposal

These entries illustrate how depreciation gradually moves cost out of the balance sheet and into the income statement without new cash flows.

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Depreciation appears as an operating expense and influences key financial performance metrics.

Depreciation is typically presented within Operating Expenses or Cost of Sales (COGS) depending on where the related assets are used.

For example:

• Factory machinery depreciation → included in COGS

• Administrative building depreciation → included in Operating Expenses

• Delivery trucks depreciation → included in Selling expenses

Depreciation impacts several financial ratios:

• Operating Margin: Higher depreciation reduces operating income.

• EBITDA: Excludes depreciation, so companies with heavy PP&E investment often show stronger EBITDA metrics.

• Return on Assets (ROA): Lower net income and higher asset bases reduce ROA.

• Cash Flow from Operations: Depreciation is added back because it is non-cash.

Clear presentation ensures users understand how closely operating performance depends on capital-intensive assets.

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Useful-life estimates, maintenance, and capitalization policies influence depreciation patterns.

Operational teams and finance departments must work together to determine useful lives based on:

• Asset condition and expected wear

• Industry norms

• Technology obsolescence

• Maintenance schedules

• Production volume (for units-of-production methods)

Companies must also evaluate repair versus replacement decisions, capital expenditure plans, and whether significant improvements should be capitalized or expensed.

Accurate depreciation policies ensure that financial statements reflect realistic economic usage and support informed decision-making regarding future investments and resource allocation.

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