Depreciation

Why spread the cost at all?

Buy $500 of office supplies and you expense them right away: they are used up quickly. Buy a $50,000 delivery truck and something different is going on. The truck is an asset that will help earn revenue for years, so charging all $50,000 against the year of purchase would make that year look terrible and every following year look artificially great, even though the truck worked equally hard in all of them.

Depreciation fixes the picture. The cost is recorded on the balance sheet as an asset, then moved to the income statement in slices over the truck's useful life. Each year bears its share of the cost, matched against the revenue the truck helped produce. Accountants call this the matching principle, and it is the whole reason depreciation exists: buying a $50,000 truck is not a $50,000 bad year.

Straight-line vs declining balance

The two common methods answer one question differently: how big should each slice be?

Straight-line is the simple one: equal slices. Take the cost, subtract any expected salvage value, divide by the useful life. A $50,000 truck expected to last 10 years and be worth nothing at the end is depreciated $5,000 a year, every year, until it reaches zero.

Declining balance front-loads the expense: a fixed percentage of whatever value is left. At 30%, the same truck is depreciated $15,000 in year one, then 30% of the remaining $35,000, or $10,500, in year two, then $7,350, and so on, with the slices shrinking forever without quite reaching zero. The logic is that many assets lose value fastest when new and cost more to maintain when old, so a bigger early expense mirrors reality better.

Which method a business uses is a judgment call about how the asset actually wears out. Neither involves any cash leaving the business: the cash left when the truck was bought. Depreciation is the bookkeeping echo of that purchase, which is why analysts call it a non-cash expense.

Two systems: your books vs the CRA

Here is the point that confuses nearly every new business owner. The depreciation in your financial statements is your accountant's estimate: chosen method, chosen useful life, chosen salvage value, all tailored to how your business really uses the asset. The tax system ignores all of it.

For tax, the CRA runs its own parallel regime called capital cost allowance: fixed rates by asset class, a mostly declining-balance method, and claims that are optional each year. Your books might depreciate a machine over 12 years while the CCA class says 20% declining balance, and both are correct in their own worlds. Book depreciation tells owners and lenders what the business earned; CCA determines what you may deduct on the tax return. The two numbers almost never match, and that mismatch is normal, expected, and reconciled on the tax return, not a bookkeeping error to hunt down.

Depreciation in everyday finance

The concept escapes the accounting department constantly. When people say a new car "loses thousands the moment it leaves the lot," that is depreciation in its everyday sense: the market value of a vehicle falls fastest in its first years, exactly the pattern declining balance is built to imitate. It is why the total cost of owning a vehicle is dominated by depreciation, not gas, and why lightly used cars can be relative bargains.

Depreciation also stars in one famous financial shortcut. EBITDA is earnings with depreciation and amortization added back, on the theory that they are non-cash and distort comparisons. The add-back is useful, but flattering: the trucks, machines and buildings being depreciated really do wear out and really will need replacing with real cash. A business that looks profitable only before depreciation may simply be consuming its equipment.

Depreciation vs amortization: one word, three jobs

A quick disambiguation, because the vocabulary is genuinely messy. In accounting, depreciation applies to tangible assets like trucks and buildings, while amortization does the identical job for intangible assets like patents and licences. Meanwhile, Canadians mostly meet the word amortization in a third sense: the schedule for paying down a mortgage or loan over time. Same word, unrelated mechanics. If the topic is a loan, amortization means the repayment schedule; if the topic is a company's books, it means depreciation for things you cannot touch.