Is depreciation an expense?

Key takeaways

• Depreciation is a non-cash expense—often treated as an operating cost—that spreads the value of fixed assets across their useful life.

• Depreciation reduces taxable income, improving short-term cash flow.

• Choosing the right method (e.g., straight line or double declining balance) affects your financial visibility and strategy.

• Startups with capital assets should track depreciation for financial reporting, tax filing, and budget forecasting.

• Rho simplifies expense categorization, including depreciation, with customizable rules and approval flows.

Yes, depreciation is an expense—but not like payroll or rent. Instead of cash leaving the business, it’s an accounting entry that spreads the cost of long-lived assets (like laptops, machinery, or vehicles) over their useful life. That way, your income statement reflects the true cost of operations each period, and your balance sheet shows how much value remains.

If you expense the full cost upfront, early results look worse than they should. Skip depreciation, and you overstate performance. Depreciation keeps your books honest—matching cost to the periods an asset actually delivers value, and showing how much it’s been used up.

In this blog, we’ll walk through how depreciation works, where it shows up in your financials, how to calculate it, and how to keep records accurate across close, audits, and tax season.

What is depreciation, and how does it work?

Depreciation is a non-cash expense that allocates the cost of a fixed asset over its useful life. Instead of expensing the original cost on day one, you record periodic depreciation expense so the income statement reflects the cost of using the asset as it generates revenue (the matching principle). 

Here’s how depreciation works each accounting period:

• Start by noting the cost, salvage value, and expected life.

• Pick a method that fits how the asset wears down (for example, straight line or double declining balance).

• Finally, record depreciation expense on the income statement and add to accumulated depreciation on the balance sheet to reduce book value.

Example of $50,000 asset over 5 years, straight line

Here’s the scenario. You purchase equipment that will support operations for several years. You also want the income statement to show the cost of using that equipment each period, and the balance sheet to show how much value remains.

• Inputs: cost $50,000, useful life 5 years, salvage value $0, method straight line.

• Annual depreciation expense: $10,000.

• Year 1 entries: the income statement shows $10,000 depreciation expense, and the balance sheet adds $10,000 to accumulated depreciation.

Depreciation rollforward, straight line

Expense is recognized evenly each period, accumulated depreciation rises by the same amount, and net book value steps down to zero by the end of the asset’s useful life.

Where does depreciation show up on your financial statements?

Depreciation appears on both core statements in each accounting period. 

• On the income statement, it is an operating expense that reduces net income, and because it is a non-cash expense, no cash leaves the business. 

• On the balance sheet, the same amount increases accumulated depreciation, a contra asset account that reduces the asset’s carrying amount, also called net book value. 

Together, these entries show the cost of using fixed assets during the period and how much value remains over their useful life. Presenting assets at cost minus accumulated depreciation gives a clearer view of net book value, but does not directly affect margin or operating expense presentation.

Here’s the period-to-period flow:

• Record depreciation expense on the income statement.

• Increase the accumulated depreciation on the balance sheet.

• Present the asset at cost minus accumulated depreciation to show net book value.

Each accounting period, you typically debit depreciation expense and credit accumulated depreciation in the general ledger. On the cash flow statement prepared using the indirect method, add depreciation back to cash from operating activities, since it reduced net income but not cash. This keeps the income statement, balance sheet, and cash flow statement aligned and makes closing and forecasting easier.

Depreciation expense vs. accumulated depreciation

Founders often mix these up. One affects this period’s profit while the other tracks the total used to date over the asset’s useful life. Together, they show cost and remaining value.

Quick comparison

How do depreciation expense and accumulated depreciation work together?

• Depreciation expense tells you what it costs to use the asset this month. Accumulated depreciation tells you how much of its value is gone.

• Accumulated depreciation answers how much value has been used so far.

• Presented on the balance sheet as original cost − accumulated depreciation = net book value.

• Both are non-cash entries that support clear financial reporting and forecasting.

If you are setting up fixed-asset categories or cleaning up your chart of accounts, our guide to business expense categories walks through how to structure categories, map GL codes, and set review rules so depreciation expense and accumulated depreciation stay in sync across close and reporting.

How to calculate depreciation

Pick a pattern that reflects how the asset provides value across its useful life, then apply it consistently each accounting period. 

Each method creates depreciation expense on the income statement and increases accumulated depreciation on the balance sheet, reducing net book value over time. Since depreciation is a non-cash expense, you’re shaping financial reporting and taxes, not cash leaving the business.

1. Straight-line depreciation method

Straight-line spreads the cost evenly across the asset’s useful life. Start with the original cost, subtract the salvage value, and divide by the number of years. The result is the annual depreciation expense you’ll recognize each period.

(original cost − salvage value) ÷ useful life

Example

• Cost $50,000, salvage value $0, useful life 5 years → annual depreciation expense = $10,000. 

• Each year, you record $10,000 on the income statement and add $10,000 to accumulated depreciation on the balance sheet, stepping the book value from $50,000 to $40,000, then $30,000, and so on.

When it fits

Use a straight-line when the asset delivers steady benefits over time and wear and tear are relatively even (furniture, fixtures, leasehold improvements, and many buildings). It’s also helpful when you want predictable operating expenses for budgeting, easier audit trails, and consistent financial statements across periods.

2. Double declining balance depreciation method

Double declining balance (DDB) accelerates expenses into earlier years. You apply an accelerated rate, twice the straight line rate, to the beginning-of-year book value and stop at the expected salvage value.

2 ÷ useful life × beginning book value

Example

• Cost $100,000, useful life 5 years → rate = 2 ÷ 5 = 40%.

• Year 1 expense = 40% × $100,000 = $40,000 (book value becomes $60,000).

• Year 2 expense = 40% × $60,000 = $24,000; continue until you reach the salvage value.

When it fits

Choose DDB when assets lose value faster up front (laptops, servers, vehicles, production tech). The accelerated pattern better matches economic reality and can reduce taxable income earlier, improving near-term cash flow while staying consistent with GAAP’s matching principle. 

It’s a fit if you refresh equipment frequently or want earlier recognition of wear and obsolescence on the income statement.

3. Units of production method

Units of production tie expense to actual usage rather than time. You compute a per-unit rate, then multiply by units produced in the period. High-output periods show higher depreciation expense; slow periods show less, aligning cost with revenue.

(cost − salvage value) ÷ total expected units = rate per unit

expense this period = rate per unit × units this period

This gives you a depreciation rate per unit that you multiply by this period’s output.

Example

• Cost $60,000, salvage value $6,000, total expected units 180,000 → rate = $0.30/unit.

• If the asset produces 22,000 units this year, the depreciation expense = $6,600.

When it fits

Use this method when wear tracks output (manufacturing equipment, presses, specialized tooling). It gives operators a clearer link between production levels and operating expenses and helps with pricing and margin analysis because depreciation scales with activity rather than the calendar.

How depreciation flows through your financials

Depreciation moves through your books even though it doesn’t touch your bank account. It affects profit, taxes, and cash flow, and if it’s inconsistent or missing, your forecasts, audit trail, and asset values can break down fast. Here's how it shows up across your statements and what to watch for.

Keep margins honest

Depreciation hits the income statement first. Each entry reflects the matching principle: you recognize the cost of fixed assets during the same periods they help generate revenue. That way, operating expenses and net income reflect the true cost of running the business, month by month.

Show the real value of assets

On the balance sheet, depreciation lowers the carrying amount of the asset over time. Each period’s entry increases accumulated depreciation (a contra asset) and reduces the net book value. This gives you a more accurate view for timing replacements, reviewing ROI, securing financing, or preparing lender reports.

Strengthen reporting and audit readiness

Depreciation is also about policy. Standardizing useful life assumptions, salvage value, and calculation methods supports GAAP reporting and smoother audits. A consistent depreciation schedule makes it easier to reconcile your statements and prepare accurate tax filings.

What happens if you skip depreciation

If depreciation is missed, inconsistent, or misclassified, here’s what happens:

• Profits get overstated

• Asset values look inflated

• Reconciliation issues show up at close

• Budgeting and forecasting become less reliable

Treat depreciation like a control, not a cleanup. Record it each period, review schedules during close, and only update assumptions when there’s a real change.

Tax implications of depreciation

Depreciation reduces taxable income even though it’s a non-cash expense. For tax purposes, the IRS treats depreciation as a tax deduction that spreads the cost of an asset over its useful life. 

Each accounting period, the expense lowers net income on the income statement. For tax purposes, it also reduces your liability, improving near-term cash flow without money leaving the business.

Section 179 and bonus depreciation

Beyond standard schedules, U.S. tax law offers two accelerators. 

• Section 179 lets many small businesses expense some or all of qualifying depreciable assets in the first year, subject to IRS limits and phase-outs. 

• Bonus depreciation provides an additional accelerated deduction on eligible property placed in service during the year.

Percentages and caps are subject to change over time, so confirm the current IRS rules before filing.

Elections for Section 179 and bonus depreciation are made on Form 4562 (Depreciation and Amortization) when you file your return.

Tax treatment vs. financial reporting

GAAP financial statements often use straight line for consistency, while tax reporting may use accelerated methods to capture tax benefits sooner. 

That’s normal, and it’s why your depreciation schedule becomes your single source of truth across tax and reporting. On the cash flow statement (indirect method), depreciation is added back to operating activities because it reduces profit but not cash.

What founders should track in a depreciation schedule

Founders should maintain a depreciation schedule that aligns tax filings with financial reporting.

For each asset, track:

• Original cost

• Depreciation method (e.g., straight line, double declining balance)

• Annual depreciation expense

• Accumulated depreciation

• Net book value

• Section 179 or bonus depreciation usage (for tax tracking)

• Placed-in-service date

• Invoice or supporting documentation

Review the schedule during close to make sure projected tax deductions match expected taxable income and cash flow. These details also simplify audit prep and help avoid missed deductions.

Simple example

A $100,000 equipment purchase might use straight line for GAAP to keep operating results predictable. At the same time, your tax strategy could apply Section 179 or bonus depreciation to deduct more in year one. 

As a result, books remain GAAP-compliant, taxes reflect accelerated deductions, and cash on hand may improve—depending on taxable income and timing.

How to set up depreciation tracking for smarter budgeting

Prepped right, depreciation becomes a clean, repeatable part of close. Use this step-by-step setup to keep your financial statements, cash flow planning, and tax returns aligned.

1. Build a complete asset list

Create a single source of truth for depreciable assets. 

For each item, record

• purchase date

• original cost (purchase price)

• useful life

• salvage value (residual value)

• method (straight line, double declining balance, or units of production)

• GL code

• placed-in-service date

• owner or location

This keeps audits simple and helps you track net book value accurately.

2. Document your policy and formulas

Document your capitalization policy, including threshold levels, how you estimate useful life and salvage value, and the calculation methods you will use. Consistency matters because applying the same rules each accounting period keeps depreciation expense and accumulated depreciation in sync and supports GAAP reporting.

3. Build the working schedule

Start with a spreadsheet if volume is light, one row per asset with columns for method, annual depreciation expense, accumulated depreciation, and net book value by period. If you manage many assets, use accounting software to automate entries and lock closed periods.

4. Post monthly as part of close

Record entries every month so the income statement and balance sheet tie out. Then, confirm the rollforward by checking that the beginning book value minus the current period depreciation equals the ending book value, and that the accumulated depreciation updates correctly. 

If circumstances change—such as an impairment, disposal, or major repair—update the schedule prospectively and document the rationale.

5. Review for taxes and planning

During close, align the book schedule with your tax strategy. Tag assets that use Section 179 or bonus depreciation on your tax return, and forecast the impact on taxable income and cash flow. Flag assets nearing the end of their useful life so budgets and replacements aren’t a surprise.

How Rho helps you manage depreciation and other business expenses

Recording depreciation is one piece; keeping every expense category clean and audit-ready is where the real value shows up. Rho helps you organize fixed-asset purchases, keep depreciation schedules accurate, and maintain real-time visibility without spreadsheet sprawl.

With Rho, you get

• Custom expense categories mapped to your chart of accounts (including fixed assets and depreciation).

• Rules based on vendor, amount, memo, or GL code so asset purchases land in the right bucket.

• Reviews and approvals that surface exceptions before close.

• A single view of operating expenses and fixed assets to support budgeting, forecasting, and audits.

If you want fewer reclassifications at month-end and clearer financial statements, Rho keeps your categories, rules, and approvals working in the background.

Turn cleaner categories into cleaner books

Tracking depreciation correctly gives you clearer books and smarter budgets. With Rho, you categorize fixed assets the same way every period, automate reviews, and flag outlier transactions before they become problems, so your income statement and balance sheet stay in sync.

We’re built for operators who want fewer surprises at close and at tax time. Map purchases to the right GL code once, apply rules by vendor or amount, and review exceptions in minutes. The result is cleaner operating expenses, better cash flow forecasts, and tighter control over tax liability without spreadsheet sprawl.

Get started with Rho today.

Other FAQs about depreciation for small businesses

Is depreciation an operating expense?

Yes. It’s recorded on the income statement each accounting period and reduces net income without affecting cash.

What’s the difference between depreciation and amortization?

Depreciation applies to tangible assets like equipment; amortization applies to intangibles such as patents or software licenses.

How do I calculate the book value of a depreciated asset?

Subtract accumulated depreciation from original cost. For example, an asset that costs $100,000 with $40,000 accumulated depreciation has a net book value of $60,000.

What is a contra asset account?

Accumulated depreciation is a contra asset account on the balance sheet. It shows total depreciation to date and reduces the asset’s carrying amount (net book value).

Can I deduct the full cost in the first year?

It depends. Section 179 and bonus depreciation are forms of accelerated depreciation that can allow larger first-year deductions (subject to IRS limits). Elections are made on Form 4562 with your tax returns; make sure to confirm current rules with a tax advisor.

How do I choose a depreciation method?

Match the pattern of use. Straight line works for steady wear; double declining balance (a declining balance method) fits assets that lose value faster early; units of production tie expense to output. Pick one that reflects useful life and supports GAAP reporting.